Structural tax reforms needed

Adjustments should encourage consumption and support eco-friendly industries and smaller market players

China's continuing economic deceleration, as indicated by its gloomier industrial added value and manufacturing purchasing managers index in August, has added more difficulties to its task of "stabilizing growth" and increased the risk of a hard landing.

The feeble exporting momentum and slow progress in digesting the accumulated inventory and expanding domestic demand have once again pushed investment to the forefront as an overpowering option to bolster economic growth. The accelerated approval by the National Development and Reform Commission, China's economic planner, of infrastructure projects across the country in recent months has manifested the government's desire to stoke economic growth through investment expansion.

At a time when international liquidity is still running high and domestic inflation pressures are starting to mount, China's monetary authorities have not got much space for monetary policy maneuvering, especially as two interest rate cuts have already been made. While adhering to a sound monetary policy, the government should lean toward the use of fiscal policy to ensure national economic growth in the remaining months of this year. It should advance its long-anticipated structural tax reduction, such as promoting tax cuts for small and medium-sized enterprises, low-carbon economic activities and high-tech products. At the same time, a higher tax rate should be imposed on the use of luxury commodities, and on large monopolistic enterprises and extensive economic activities.

For many years, the leverage of taxation has not been given a full role in the country's fiscal policy, and most of the time taxation has been used as an instrument to increase government revenues. The country has implemented numerous tax reduction measures since 2009, such as the adoption of preferential tax policies for small taxpayers, tax reduction or exemption for logistics companies, and raising the threshold for individual income tax. But it has also raised other taxes, such as the urban construction tax, the education surtax, the tax for urban land use and the land appreciation tax, which have increased the revenues of local governments. Statistics show that the country's fiscal revenues reached 6.38 trillion yuan ($1.01 trillion) in the first seven months, an increase of 11.6 percent year-on-year, two percentage points higher than expected.

The government should restrain its investment impulses and try to change its excessive dependence on investment to realize the target of establishing "a small government and big market". Pushing for structural tax reductions, realizing a balance between government revenues and spending, and promoting reforms of the country's fiscal and taxation systems will help facilitate the smooth realization of this.

The government should be well aware that small and medium-sized enterprises, which account for more than 90 percent of the country's enterprises, will be the main driver of national economic development as the global economic environment worsens. If the value-added tax is slashed from the current 17 percent to 13 percent, it will provide a big boost to the real economy.

Due to the lack of an overall institutional design, China's structural tax reduction program is still in the experimental stage. That means it is not only difficult for structural tax reduction to play its role as an effective regulatory means, it is also difficult to offer a substantial boost to the manufacturing sector. Currently, 80 percent of China's tax comes from large and medium-sized enterprises, but its structural tax reduction is mainly targeted at small enterprises. So, even a full tax exemption for small enterprises is not expected to have a big impact on the country's tax revenues.

However, structural tax reduction not only means carrying out larger-scale tax cuts, it also means some taxes should be reformed and new taxes imposed. As well as the forthcoming environment tax, over the past year, the country has been considering some new tax categories, reform of the resources tax and the consumption tax, and the extension of its pilot property tax. The country also plans to raise taxes on high energy consuming and non-renewable consumer goods.

At present only Shanghai and Chongqing impose a property tax, extending this to other cities would swell local coffers and help ease the revenue imbalances between the central and local governments following the adoption of the central government-favorable tax division system in 1994. It would also mitigate the pressure on local governments to raise revenues by selling land and encourage them to take more forcible measures to rein in high housing prices.

From a long-term perspective, a sustainable and stable tax source will also beef up local governments' capability to improve public services, stop them pursuing short-sighted economic activities, and facilitate the transformation of the country's current economic development mode.

Zhao Xiao is a professor with the School of Economics and Management, Beijing University of Science and Technology, and Shi Guicun is a member of the university's Research Section of China's Economy.

(China Daily 09/28/2012 page8)