It's high time tax reform started
By Gao Peiyong (China Daily)
Updated: 2005-03-07 09:40

[The author Gao Peiyong is a researcher at the Institute of Finance and Trade Economics, Chinese Academy of Social Sciences.]

The principles of the new round of reform of the taxation system, which has been under discussion for quite some time, were outlined in the Decision of the Central Committee of the Communist Party of China on Issues Regarding the Improvement of the Socialist Market Economic System, which was issued at the third plenary session of the 16th Communist Party of China Central Committee in October 2003.

The necessity and importance of such a reform are well-known in the country, in businesses, academia and government departments. They all have high hopes for the reform.

However, the reform has not been initiated except for the changes in procedures for rebating taxes on exported products.

To sum up, the major obstacles for launching the reform are concerns over two prospects. First, there are concerns that the tax reform would cause a large reduction in tax revenue. Second, some people are worried that the already overheated investment in fixed assets would be further boosted by the tax reduction.

Therefore, easing these concerns is the key to initiating the tax reform.

Admittedly, the tax reform would cut down revenue. To be specific, the reform measures on value-added tax and enterprise income tax would involve a reduction to as much as 200 billion yuan (US$24.1 billion).

When the State coffers are far from full enough to support all the needs calling for government input, it is natural for the authorities to remain prudent on the tax reform.

Yet, suspending the tax reform solely because of the fear of tax income reduction cannot be a solution to the problems waiting to be addressed.

Reform may never be initiated if we wait until State income from taxes rises enough to withstand a reduction.

By examining fiscal income and expenditure in the last 10 years, it is easy to see two inter-related tendencies.

Fiscal income has been on a continual rise since 1994 and the annual growth rate is also higher each year.

The breakneck rise lasting for a decade has put total fiscal income at an unprecedented level. The tax income in 2003 was 4.7 times that of 1993.

With the support of swelling tax income, fiscal expenditure expanded with an even stronger momentum during the same period. Fiscal expenditure in 2003 was 5.7 times that of 1993.

In other words, the growth in tax income has been directly translated into the boom of fiscal expenditure.

The net increase in total tax income in 2004 was 525.6 billion yuan (US$63.3 billion), which is at least 300 billion yuan (US$36.1 billion) more than predicted.

If no special arrangements are made, the huge swell will directly lead to similar growth in fiscal expenditure.

Once that happens, fiscal expenditure will be further boosted. Expenditure by government departments at all levels would also grow accordingly, which makes consolidating fiscal expenditure in the future a more challenging task.

As a matter of fact, tax income growth has reached its climax and will soon follow a downward curve.

We have always seen the speedy growth in tax income attributed to economic growth, policy adjustment and enhancement in tax collection.

The elevated tax income growth in 2004 is mainly driven by the following three factors economic growth, price hikes and enhancement of tax collection.

However, no matter what the specific factors are for the three pillars of tax income growth, economic growth is the only factor that could be relied upon in the long term.

According to the estimate of the State Administration of Taxation, the taxes actually collected have reached 70 per cent of all payable taxes by enhancing tax collection. The proportion was only 50 per cent before 1994.

As the proportion goes up, it will be increasingly difficult to further boost it.

Since the inflated tax income growth would cause the swell of fiscal expenditure while the tax reform could cut down tax income, it is better to use increased taxes to launch tax reform when tax income is booming.

It is easy to see that tax reform, which will reduce taxes, would definitely provoke investment.

However, when the background of rocketing tax income growth is considered, the conclusion could be different.

As mentioned previously, the larger than usual tax income growth will result in the equally increased rise in fiscal expenditure and even stimulate the impulse for investment in fixed assets from the government departments which have been hushed by the central government for a while.

Although tax reduction would result in the expansion of investment, the expansion is unlikely to be bigger than that caused by the swell in fiscal expenditure.

Compared with the increase in fiscal expenditure and its provocative role in stimulating fixed assets investment, the potential negative effects of tax reform become much less significant.

On top of that, tax reform could consolidate the taxation system, which is a final goal for us.

Looking at economic reform during the last 26 years, it is easy to see that tax reform always plays a pioneering role.

The tax reduction at the early stage of the reform helped launch economic reform. The tax reform in 1994 also paved the way for further innovations in economic and fiscal systems.

Given the special position of tax reform in China's history, it is natural that it should lead off a new round of economic reform.