China Should Broaden Its Tax Base

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 Stephen Groff, Vice-President of the Asian Development Bank, in a speech at the China Development Forum 2013, declared that the first step for China to take should be to broaden its tax base.
 He noted that greater efforts are needed to address major constraints, despite the fact the China "has undergone significant fiscal reforms in recent years that have helped to build a solid fiscal position."
 Fiscal revenues have increased from less than 10% of GDP in the 1990s to 20% of GDP currently, but Stephen Groff commented that they are still relatively low compared to OECD countries, making it difficult to allocate adequate public resources to basic social services.
 While social spending has increased rapidly in recent years, he said that it too remains relatively low. About 35% of government revenue is spent on social security, education and healthcare, compared with an average of 52% in other middle-income countries. Moreover, recent reforms have focused on expanding the coverage of benefits rather than restructuring the benefits themselves.
 While the Government is piloting some important initiatives, such as the introduction of a property tax on luxury housing in Shanghai and Chongqing, Groff called these taxes " a step in the right direction," but "the ultimate goal must be a genuine property tax based on home values and universally imposed on all urban homes."
Furthermore, he added that the pilot program to introduce a VAT on services in selected cities and sub-sectors has proved highly successful, but the scope of the pilot is restricted to 12 cities and municipalities.
He believed that, while economic growth should be sustained, further fiscal reforms will be necessary to support economic rebalancing and narrow the income gap.
 Firstly, Stephen Groff said that "the tax base should be  broadened. Recent reforms increasing tax thresholds have reduced the number of personal income tax payers to less than 3% of the population. Tax evasion is high, and collection and enforcement are low."
 "More importantly," he pointed out, "the base leaves policy-makers with no powerful income distribution tool. Last year, the share of personal income tax i China's total fiscal revenues reached less than 6%, far below the OECD average of 24%. The income tax base can be broadened through measures to curtail tax evasion, reduce the informal sector in the economy, and strengthen tax administration."
 Secondly, Groff looked for an increase to the progressivity of taxation. Currently, VAT is China's single largest source of tax revenue but is regressive,while more direct taxation could be more effective in adjusting income differences, and therefore be more equitable.Taxing capital gains and property, introducing inheritance/gift taxes and an environment tax, would also help to balance income distribution.
 Thirdly, he considered it essential that there should be an overhaul to be tax revenue sharing system between the central and local governments. One approach, Groff recommended would be to increase existing transfers of fiscal resources from the central government and the share of VAT revenue accruing to local governments to ensure sufficient funds for an adequate provision of social services at the local level. "Without such reforms'" he concluded, "large disparities in public social spending per person will emerge, and perpetuate inequality."