Personal Income Tax Revolution of China
Public Finance
Han Zhang
A personal or individual income tax is levied on the total income of the individual. As an important tax of china, and also an important tool for regulating income distribution to narrow the gap between the rich and the poor, it did not play the desired effect. Nowadays, the personal income tax reform has become the focus of the society; the requirement of increasing personal income tax expense standard deduction keeps rising, the reform is urgently needed.
The personal income T ax reform
In the twenty-first meeting of the Eleventh National People's Congress Standing Committee in 2011, the government raises the personal income tax from 2,000(Yuan) to 3,500(Yuan), as a biggest tax cut action in the history.
The biggest beneficiaries will be those at the bottom of the tax scale. The lowest rung of the income-tax ladder has been raised from 2,000 Yuan ($313) per month to 3,500 Yuan ($547). The average Chinese wage is around 3,000 RMB a month.
As a developing country, China relies very little on hard-to-collect income tax for its revenue. Last year it raised only 6.6 percent of its taxes from personal income. Instead, the government goes after the business sector, which is easier to monitor.
China's current tax system is a classified personal income tax system, it classify the different income of the taxpayer, and then separately taxed to obtain the total tax
revenue. Such a tax system makes the wage earners of single income to pay more taxes, while the high-income group pay less by their diversify sources of income.
The implementation of "a same standard" for all taxpayers, regardless of the severity of the taxpayers' family burden, the amount of household spending, makes the low-income families experience a hard life. In some countries of which the tax system is more mature, in general, they run a combined personal income tax system. And take the family as a whole for tax has long been an international practice.
We are still on the exploring way of the personal tax revolution, and are happy to see the process. The several important tax reform actions after 1978 — as known as the year of reform and opening-up are following listed:
In September 1980, the third session of the Fifth National People's Congress adopted and published Individual Income Tax Law of the People's Republic of China. China's personal income tax system was officially established at this time.
In September 1986, to deal with a significant change in personal income for China's domestic situation, the State Council issued the Provisional Regulations of the People's Republic of China on personal income adjustment tax, and unified collection of personal income tax adjustment provisions of the personal income of its own citizens.
In October 1993, the fourth meeting of the Eighth National People's Congress adopted a decision "on the amendments to the PRC Individual Income Tax Law" amendment to provide that, regardless of inside and outside, all the Chinese residents and non-residents who has the income from China, should pay personal income tax in accordance with the law.
In January 2002, the personal income tax revenue would be distributed between the central government and local governments proportionally.
In October 2005, the 18th meeting of the Tenth NPC Standing Committee adopted a decision to raise the personal tax standard of 1,600 from January 1, 2006.
In March 2008, the personal income tax standard raises again from 1,600 to 2,000 a month.
In June 2011, the twentieth meeting of the 11th NPC Standing Committee
decided that increase the tax exemption amount from the current 2,000 to 3,500, and at the same time decrease the first level personal income tax rate to 3%.
The economy of China is keep growing, and with the reform of tax system, distribution system, the personal income tax would play a more and more important role in China’s tax revenue and also the public finance work.
The history of personal income tax
The origin of the personal income tax is to collect military spending. The world's first country to levies personal income tax is the British. To finance the costs of the war against with France, the personal income tax was created in 1798, mainly collected from the high-income earners. In addition to levy a tax, the main way of British to finance its military spending is to issue government bonds. Whether to levy a tax on high income earners, or to issued government bonds, it is a more equitable way than to apportioning the costs of war to the whole of society. Levy a tax at the time was just a temporary move, in 1802 as the war ended; the tax was abolished and finally established till 1874. In the last two or three decades, the personal income tax accounted for 40% of the total tax revenue in United Kingdom, and is the largest tax of the country.
U.S. personal income tax began during the Civil War. In 1861, the Civil War broke out, the U.S. federal government, in order to raise funds for the war, approved the levy of a 3% personal income tax of people who has an annual income of more than $ 800. The personal income tax was modified in the following year, and repealed in 1872. Then it was re-levied in 1894, but the following year got abolished again. By the new Personal Income Tax Law in 1913, the threshold is too high; only one person in every 271 individuals could reach the minimum threshold. The tax rate was adjusted in 1943, and then taxpayers increased. After the reform of 1954 and 1986, personal income tax law in the United States is substantially completed. Its main feature is the implementation of the comprehensive income tax system, consideration of the family members, and there is a lot of credit for the return project. At present,
the personal income tax is one of the two major U.S. taxes.
After World War II, the personal income tax was introduced world widely. China's personal income tax began in the late Qing Dynasty. The Qing government had drafted the regulation of Association of the Income Tax, containing the content of personal income tax, but did not get implemented at that time. In the early time of 20th century, China developed a tax implementation details and the method of collection, but also failed to implement. In 1936, the personal income tax finally got implemented. At the beginning of liberation, the government had levied a tax on interest income, and then ended in 1959. In 1980, the National People's Congress promulgated the PRC Individual Income Tax Law. But the threshold of 800 (Yuan) a month is quite high, there’s rare people could reach the standard, so income tax revenue is negligible.
Since the 1994 tax reform, the personal income tax is becoming more and more important in tax system, the proportion of personal income tax in total tax revenue is keep increasing. In 1990, the total amount of personal income tax is only 2.11 billion Yuan, in 1995 it rose to 13.13 billion yuan, in 2000 the amount is 65.96 billion yuan, and till 2010 it reached to 483.72 billion yuan. The proportion of personal income tax in total tax revenue in those years rose from about 0.7% to about 2.2%, to about 5.2% and to 6.6% in 2010. At present, the personal income tax ranked sixth in China's largest tax and exclusive behind the domestic value-added tax, corporate income tax, import tax, sales tax, and domestic consumption tax.
Personal income tax is generally considered a good tax in the world,, because it has functions of adjust the personal income, to narrow the gap between rich and poor, and to maintain social equity. In accordance with the current personal income tax law and the implementation, this goal is difficult to achieve. One of the most important reason is because some high-income people are not rely on legal income, but the illegal income and gray income, such income is difficult to be included in the areas of taxation. Raise the tax threshold of course allows the wage earners to pay less tax, but it does not have much meaning of social justice, because the other burdens are too heavy.
The challenge of changing the tax base
Since China is considering creating a nationwide individual tax information database, widely regarded as the first step in clearing technical hurdles for wider tax reform, has triggered a fresh wave of discussion about the country's taxation system. The database is reportedly being created to lay a foundation for moving individual income taxes toward a fairer collection process based on gross family earnings. But experts have said that family-based tax collection will be difficult to pull off in the short-term, as the change will require a complete overhaul of the current taxation system.
China's current income taxation system, which mainly taxes personal income according to income sources, has long been criticized over loopholes and a lack of consideration for family expenditures. The divided tax items may lead to a tax gap between people with multiple channels of income and those with a sole income source, said Zeng Kanghua, head of the Finance and Tax Research Institute at the Central University of Finance and Economics.
Although many taxpayers are around the same income level, family expenditures, including education and elderly care, can vary substantially, said Huang Hehong, associate professor of the School of Law at the Chinese People's Public Security University.
“Levying taxes based on family units will help fully reflect the actual financial status of taxpayers,”Huang said, adding that the change will help to promote fair distribution.
But many obstacles need to be removed before the final implementation of the plan, as the country must first shift to a gross income taxation system in order to create a base for family-based taxation. “If you cannot tax individual incomes as a whole, you cannot tax family earnings as a whole,” said Zhang Bin, a researcher at the Institute of Finance and Trade Economics under the Chinese Academy of Social Science.
To switch to a gross income taxation system, authorities will first have to create a series of support measures, including the previously mentioned database and a tax declaration system.
The country's large population will pose a major challenge if China shifts to family-base income tax, said Jia Kang, director of the Research Institute for Fiscal Science under the Ministry of Finance. Jia said international practices include a family-raising coefficient to compute individual taxes, although the method requires sophisticated management conditions in order to verify information filed by taxpayers.
Zhang Bin said that since family-based taxation requires more information to be filed, authorities should create related verification measures and design tax deductions for different cases.
“Family-based taxation will require careful and thoughtful design, considerable cost and certain conditions. China isn't ready yet,” Zhang said.
Threshold≠Deduction
In China, the most familiar concept of personal income tax is the "threshold": from the 1980 threshold, the threshold first came out at 800 (Yuan) a month, and rose to 1,600 (Yuan) in 2007, then 2,000 (Yuan) the following year, till now it reached to 3,500. Over the years, many people even take the tax reform equivalent to the adjustment of the threshold.
“Threshold, in fact, is a misread of deduction. As a deduction the most important features should be the difference. For the people of different economic situation, we should apply different deduction provisions, to reflect the net income principle of taxati on.”Gao Peiyong said, in China, the reason why people are accustomed to misread the deduction as a threshold, is that the existing personal income tax system implemented a standardized deduction - let the people of the different economic situation take a same standard deduction. The individual tax adjustment which ignores the difference conditions in expenses between people is clearly contrary to social
equity.
Household livelihood expense deduction is a major consideration of the scope of the personal income tax deduction around the world. In general, we should fully take care of the different family status of different taxpayers, to make a more equitable tax burden between taxpayers.
At present, China only set a fixed deduction of individual basic living expenses such as clothing, food, shelter and transportation. While some important factors like family maintenance, education expenses are not fully taken into account. The standard deduction of the cost of living is low and can not meet the actual needs of the personal social life. In the future of our country, a couple should support four elderly people, and raise a child, the "421" family model urgently need tax reform to alleviate the burden of living.
The professor of Central University of Finance and Taxation, Liu Huan said, the deduction of income tax expense should meet a indexation adjustment annually,to eliminate influence of the rise in income on income distribution which caused by the inflation factor.
“And the regional development of China is uneven; the sectional income gap is big; the feeling on prices and living standards are also not the same. The expense deduction is necessary to take a regional reform on the basis of the policy of the central government, develop a deduction policy to adapt to the region's income level and living standard. We should work hard on the rationality of tax policies.”
The Generation of Revolution
From a global perspective, developed countries generally experienced the personal income tax reform by the transformation from the classified income tax system to the comprehensive income tax system. From the 1970s to the present, the Japanese tax rate structure gradually simplified and the maximum rate greatly reduced. At present the main tax-free projects and pre-tax deductions in Japan are up to 20 items.
At the beginning of reform and opening up, to establish the classified personal income tax system in China, is under the consideration of the reality that the personal income monitoring methods are backward, personal income grasp of the information is not accurate.
From a classified system to a comprehensive system, all the conditions required by the reform are complex and harsh. It depends on the collection and management level of the tax authorities, the taxpayer's level of tax compliance, the level of collaboration of the network of social tax, and so on. The tax reform is under an urgent situation, but the lack of basic conditions is still a big problem.
To adapt to the personal income tax reform, there are two basic requirements. One is to strengthen the monitoring of the comprehensive personal income, in particular the monitoring of the diversified forms of income of high-income people. The other one is to provide clear and effective information of personal expense and burden.
It is unrealistic that everyone relies on the limited manpower, and asks the tax authorities to verify tax information. The long-term plan for the system reform is to encourage the tax return. On one hand, to expand the education of the tax system to citizens from childhood, change the passive tax habits, improve acceptance of paying tax of the whole society to pay taxes. On the other hand, to strengthen the transparency of the financial expenditure, put the taxpayers' money to the place it should be.
In China, the current level of tax administration and the degree of development tax cultural is still low, and not enough to establish a sound personal income tax system. But we can take some positive and effective measures to improve the basic conditions, and will finally make a good system for the whole country.
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