Preventing wealth polarization

Reform of the income distribution system imperative to reduce the widening income gap in China

China has to address the widening income gap as it is a challenge to social stability and economic development. The current fiscal arrangement plays a less-than-satisfactory role in the redistribution of income, the fiscal spending on public services is not enough, and the urban-rural disparity in the provision of public services is enormous. For years, the Gini coefficient has exceeded the warning line of 0.4 and the urban-rural income ratio has been hovering between 2.5 to 3.1. When the differences in the quality of public services provided are taken into account, the urban-rural disparity is even larger. In a word, the government needs to spend more on improving people's welfare.

The mismatch between the government's responsibility and fiscal power hampers the fair distribution of wealth. A tax-sharing system introduced in 1994 defines the respective responsibilities and fiscal powers of the central and local governments. In recent years, the costs of some rural basic public services, such as compulsory education, healthcare, and social security, which used to be borne by rural residents themselves, have been covered by the fiscal budgets of the local governments. This, on the one hand, has reduced the financial burdens on farmers, but on the other hand, has weighed on the fiscal health of the local governments.

The role of government transfer payments in income redistribution is still weak. Although China has made marked progress in improving the transfer payment system to narrow the income disparity among different regions and different groups, there remain some problems to be solved.

In economic development, equal importance should be given to efficiency and equity to prevent wealth polarization. To tackle the problem, reforms are needed.

First, what a modern market economy requires is a multi-level taxation system composed of many types of tax. To narrow the income gap via multiple channels, China needs to build a complete taxation system including value-added tax, consumption tax, resources tax, environmental tax, corporate income tax, individual income tax, property tax, inheritance tax and gift tax, and social security tax.

For instance, levying an inheritance tax can help prevent the income gap from widening because an inheritance tax could make up for the deficiency in individual income tax, which targets only the formal incomes of residents, and make redistribution of social wealth fairer by taxing the informal incomes of a testator during his or her lifetime.

Second, the fiscal spending structure should be optimized and investments in basic public services ramped up. More fiscal resources should be channeled to improve people's livelihoods, to strengthen areas of weakness concerning rural areas, agriculture and farmers, and to promote the development of less developed areas. It is also imperative to allocate more fiscal resources in favor of underprivileged groups.

Third, the fiscal relations between the central and local governments need to be straightened out. It is necessary to properly define the respective fiscal powers and responsibilities of the central and local governments. The delivery of public services concerning people's essential needs should be partially undertaken by the central government, along with the handling of issues related to resources and environmental protection. Also, cross-region judicial and administrative duties should be in the hands of the central authorities. Local governments should have corresponding fiscal powers and it is important to accelerate the building of a local taxation system.

Fourth, the transfer payment system should be reformed to ensure equitable access to basic public services. Efforts should be made to streamline the transfer payment system and improve the allocation methods for transfer payments. Management of funds earmarked for transfer payments and other special purposes should be improved. It is also necessary to explore new approaches to cross-regional transfer payments and improve the transfer payment mechanism to provide better basic public services to migrant workers.

Fifth, the social security system needs to be improved to moderately raise residents' transfer income. It is important to improve the social insurance system and strive to cover all citizens. The social insurance coverage of migrant workers and people flexibly employed should be markedly increased. The building of urban and rural social assistance systems should be coordinated. The old-age insurance system for urban employees should be improved, and efforts need to be made to develop a multi-tiered and multi-pillar pension system which comprises basic pensions, enterprise annuities and commercial insurance products voluntarily purchased by individuals. Individual tax-deferred commercial endowment insurance should be introduced.

The country needs to push for nationwide unified management of the employee basic pension fund, improve the system of personal pension insurance accounts of urban employees and build the incentive and constraint mechanisms for pension contributions. The unemployment and work-related injury insurances should play a bigger role in protecting the rights of employees, and the insurance contribution rates should be adjusted more flexibly. A more convenient social insurance transfer mechanism should also be established. Some State-owned assets need to be transferred to social security, and investment channels should be expanded for social security funds to increase investment returns with proper emphasis given to risk management.

Jia Kang is chief economist of the China Academy of New Supply Side Economics. Su Jingchun is an associate professor at the Chinese Academy of Fiscal Sciences. The authors contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.

Contact the editor at editor@chinawatch.cn.