By Li Chengjian

Research Report Vol.18 No.5, 2016

On March 18, 2016, the executive meeting of the State Council approved to extend the pilot program of replacing business tax (BT) with value-added tax (VAT) to more sectors. Since May 1, 2016, four more sectors, namely construction, real estate, finance and civil service, have been included in this program[], which indicates BT is to be replaced by VAT in these sectors. This move in tax reform will have profound impacts on the sectors in the pilot program and others as well. Tax incidence of the sectors in the pilot program will be different due to the VAT rate set for these sectors and different deductible input tax amount. Other sectors will be benefited from greater deductible input tax amount. Due to different proportions of intermediate input in pilot sectors, there is a great change in tax incidence in these sectors. Some companies may face greater tax incidence. Other sectors may enjoy tax reduction to different degrees, as they use different proportions of intermediate input from the pilot sectors. The input-output table carries information about the intermediate input in various sectors, which not only clearly shows the amount of deductible input tax of a sector and helps calculate the tax incidence before and after VAT-replacing-BT program, but also helps make comparison across sectors. This paper will analyze how the extension of the program facilitates tax cuts based on the input-output table.

I. Current Progress of VAT-Replacing-BT Program and Tax-Cut Situation

First trialed in 1979, VAT was officially collected in 1984[]. A decade later, China reformed the tax system into a turnover tax system including VAT, BT, consumption tax and tariffs. In 2009, production-based VAT was changed to consumption-based VAT, and investment was eliminated from the tax base to narrow VAT tax base. At present, VAT is the biggest tax category in China, accounting for 24.9%[] of the tax revenue at the end of 2015. The central and local governments share it by 75% and 25%, respectively and the former also set up the tax-rebate mechanism. Besides, BT is the third largest tax category, accounting for 15.5% of the total tax revenue at the end of 2015, which is the major source for local fiscal revenue.

The program of replacing BT with VAT, starting from 2012 in Shanghai, has been extended nationwide and included more pilot sectors. Up to now, all sectors which paid BT previous will pay VAT instead, and the former will exit from China’s tax system. Such a change will greatly reduce tax burden on all types of enterprises. From 2012 to 2015, some 641.2 billion yuan of tax has been cut as a result, among which 313.3 billion yuan was reduced for tax payers in this program, while an accumulative amount of 327.9 billion yuan was cut for other tax payers thanks to more deductible input tax. Hence, the program of replacing BT with VAT has equal significance of cutting tax for both pilot sectors and those sectors paying VAT previously.

Nonetheless, there are still some problems. First, how different sectors are interrelated when VAT is calculated is not well understood, which will be gradually solved as the program of replacing BT with VAT extends to more sectors. The problem of double taxation will also be solved. Second, VAT is not paid in a regulated way, which makes tax incidence different. Some companies which paid BT previously fail to follow related requirements when paying VAT for inputs. So they may have little deductible input tax and incur more tax incidence in the short term after VAT reform. However, in the long term, this reform helps regulate tax-paying behavior and reduce tax. Third, huge differences exist in the changes of tax incidence across different sectors. With more deductible input tax on intermediate input, more or less tax-cut has been achieved for all sectors. But the change of tax incidence varies across sectors and across enterprises in the same sector. Therefore, further adjustment is indispensable. Fourth, with tax cut, local governments are in need of principal tax. This round of extension of the pilot program replacing BT with VAT is expected to cut tax further. This is particularly important for local governments because they will let go their principal tax, BT, and have to think ahead about what kind of tax will be the successor.

II. Specific Impacts of Overall Extension of VAT-Replacing-BT Program on All Sectors

In real practice, VAT payable is calculated by subtracting the deductible input tax from the output tax based on the sales volume. Because of the features of VAT, tax amount is not only related to the applicable VAT rate, but also closely connected with deductible input tax of the intermediate input. The input-output table shows how each sector uses products of other sectors as intermediate input, and gives us feasible ways to study details of input tax in all sectors. The latest input-output table available is the Basic Input-Output Flow Table 2012[ See China Statistical Yearbook 2015, National Bureau of Statistics of the People’s Republic of China. ], which includes 17 sectors, all of which are ranked in Table 1 in the descending order of proportion of intermediate input. ...

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