More tax reduction a viable option

Since the Chinese authorities implemented policies to alleviate the tax burden of the people, especially those with dependent parents (mostly senior citizens) and young individuals two months ago, it is too early to assess their effectiveness.

As a result, the question of whether there is a need for more tax cuts continues to be debated. But if the burden of personal income tax is further reduced, it might help accelerate the economic recovery by boosting consumption.

On Aug 31, the State Council, China's Cabinet, announced additional deductions for children below three years of age, children's education and elderly support for individual income tax payers. This is a targeted measure aimed at easing the financial burden of middle-income families, especially those with young children/or elderly family members. The standard deduction for children below three has been increased from 1,000 yuan ($137) to 2,000 yuan per child per month.

China is facing a critical demographic challenge with a birth rate of 6.77 per thousand (in 2022), a death rate of 7.37 per thousand, and a natural population growth rate of — 0.60 per thousand. The total fertility rate in China, too, is well below the replacement level of 2.1 — required to maintain a stable population. Without effective measures, therefore, China's population is at risk of a rapid decline, which could have serious implications for the country's future.

While a declining fertility rate is a common phenomenon in modern society, it can be mitigated with effective policy measures. A substantial population decline would create a demographic imbalance with a rapidly growing aging population, impacting both the economic and social fabric of the country. To address this challenge, the country needs robust policy measures.

In recent years, the easing of the family planning policy, including allowing all couples to have three children, has created conditions for population growth which in turn can help maintain the demographic balance. However, maintaining the population equilibrium necessitates a comprehensive public policy framework, with the tax policy being an important aspect of it.

The increase in standard deduction for children's education, from 1,000 yuan to 2,000 yuan per child per month, is a tax policy aimed at reducing the cost of raising children and thus encouraging couples to have two, if not three, children. This is a positive incentive for families which may have refrained from having more than one child or decided to have no children at all.

China's rapidly rising aging population is a major concern — the country had about 209.78 million people aged 65 or above by the end of 2022, accounting for 14.9 percent of the total population. China has already entered the stage of an aging society. So the burden of supporting the elderly is increasing, with less than two tax payers supporting one elderly person. That's why the increase in the standard deduction for elderly support, from 2,000 yuan to 3,000 yuan per month, will ease the financial burden of families and support eldercare in society.

The personal income tax deduction for the three special categories can, by default, increase the disposable income of middle-income individuals and families, potentially stimulating consumption. While the extent to which this increase in disposable income will translate into consumption remains to be seen, the move could increase households' savings.

The tax reduction is not about raising the tax-free threshold of 60,000 yuan a year. Instead, it is targeted at specific areas of need, paying special attention to households with elderly family members and/or young kids. The social significance of this policy is thus immense.

China has introduced large-scale tax and fee cuts during the past several years, resulting in a relatively low macro tax burden. In 2022, tax revenue accounted for only 13.8 percent of China's GDP, which may not be enough to support the government to provide high-quality public services.

Besides, looking at the direction of tax reform, there is limited room for significant reduction in personal income tax. That's why, in the future, the tax authorities need to gradually increase the proportion of direct tax revenue. Given the difficulty in increasing revenue from other direct taxes such as property tax, the important role of personal tax in the direct tax system needs to be maintained.

But this does not mean there cannot be moderate or structural tax reductions in the future. China's comprehensive income tax, with a top marginal tax rate of 45 percent, may discourage top international talents from working in China and promoting its development. Lowering the top marginal tax rate or expanding the tax brackets, such as by changing the 45 percent rate threshold for incomes between 960,000 yuan and 1.92 million yuan a year (double the previous threshold), with corresponding reductions in other tax rates, is a policy option the tax authorities could consider.

Importantly, lowering of tax rates, so long as the tax base expands, may not necessarily cause a decline in overall tax revenue. Therefore, any future tax reductions or structural changes should consider both the economic and fiscal impacts of the change. As long as the tax burden is stable, tax reductions remain a viable policy option.

The author is director of the Center for Public Finance and Taxation Research, Chinese Academy of Social Sciences.

The views don't necessarily represent those of China Daily.

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