25 October 2016
China has to resolve the issue of tax income distribution between the central and local governments. Photo: Bloomberg
China has to resolve the issue of tax income distribution between the central and local governments. Photo: Bloomberg

China faces a long and difficult road in tax reform

China has in recent years begun reforming its tax regime in a bid to reduce the tax burden on businesses amid slowing economic growth.

One of the key measures is the “business tax (BT) to value added tax (VAT)” reform.

Such reform would change the distribution of tax income between the central government and the local governments.

Normally, local governments hand over part of their total tax income to the central government and the central government gives some of its tax money to help subsidize the regions that have lagged in economic development.

Thus, the wealthy eastern provinces have long been the givers.

Although the government has promised to cut taxes, it’s not clear whether authorities will cut the part that belongs to the local government or that of the central government.

In the case of BT to VAT reform, a quarter of VAT income will be kept by local governments while the remaining 75 percent will belong to the central government.

In the case of BT, local authorities keep 100 percent of the income.

According to data from the Ministry of Finance, China’s VAT revenue last year amounted to 3.11 trillion yuan while the BT was 1.93 trillion.

Under the tax income distribution arrangement, there is no doubt that local governments will lose a key part of their tax sources. No wonder they are reluctant to push forward the reform.

The central government has said that it will fully implement the BT to VAT reform in all industries, including finance, property and consumer services, during this year.

Everyone knows that finance and property are pillar industries for the mainland economy. So the impact of full implementation will be much bigger than that during the pilot period when only some industries, like shipping, were included in the reform.

The distribution arrangement then becomes a dilemma. Some reports said the central government is proposing a 50-50 distribution with the local administrations, but the developed provinces in eastern China are suggesting an unequal arrangement.

The detailed arrangement will not be known before August.

The present tax regime in the mainland is very complicated, and so are the government system and the personnel issues. Battles always exist between central and local governments.

Although the present top leaders are more powerful than their predecessors, voices from the local governments cannot be neglected.

It will be a long journey for China in carrying out all its tax reforms. Mainland companies will find that their tax burden situation is unlikely to improve much in the short term.

This article appeared in the Hong Kong Economic Journal on April 8.

Translation by Myssie You

[Chinese version 中文版]

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