It has been nearly one year since China kicked off its value-added tax reform, on a trial basis, in the northeastern provinces of Heilongjiang, Jilin and Liaoning.

But it remains unclear when the reform which allows companies to claim value-added tax rebates for purchases of fixed assets, such as equipment and machinery will spread across the country.

Researcher Ni Hongri, with the State Council's Development Research Centre, says the reform is still in the experimental stage.

"Relevant government departments and experts are studying ways of improving the reform scheme," she says.

The central government wants to understand the results of the trial reform, and what problems, if any, exist.

"The government must be very careful, because the reform will affect not only fiscal revenues, but also the entire macro economy," she says.

With the aim of evaluating the results of the trial reform, a group of experts from the International Taxation Institute of China, some of whom are retired from leadership positions with the State Administration of Taxation, are planning a trip to Northeast China.

Insiders say they will summarize experiences gained from the trial reform, and begin preparing the scheme's expansion across China.

The reform, which benefits thousands of companies in Northeast China, was announced last October. It took effect on July 1 last year.

Taxation authorities have yet to release the latest figures from the trial.

Earlier figures indicated, by the end of last October, 40,508 companies in the three provinces had benefited from the reform. The companies had obtained a combined tax rebate of 284 million yuan (US$34.2 million).

Ni says the rebate, although not very big, can increase companies' enthusiasm to invest.

"This is what the governments want to see in their efforts to revive the old industrial bases in Northeast China," she says.

Increased investment, resulting from the trial, which, in fact, reduces companies' financial burdens, will help firms in the three provinces as they reform, she adds.

Finance Minister Jin Renqing says the trial has achieved some results.

He says he hopes the reform will spread across China as soon as possible.

China in 1994 adopted a production-based, value-added-tax system. Under the system, fixed assets are classified as consumer goods, and are subject to the tax.

Companies cannot claim a tax rebate for purchasing fixed assets such as equipment and machinery.

Jin says the design of the tax, in 1994, was in line with the real economic and fiscal situations at the time, when the country coped with inflation.

The tax system helped curb investment, he says.

But in the face of deflation, the impacts of the tax have been negative.

It will affect companies' enthusiasm about increasing investments and upgrading technology, which is not favorable to economic development, Jin says.

The tax system is also not in line with international trends, he says.

Currently, only China and Indonesia have production-based value-added taxes.

To increase companies' internal vitality and competitiveness, stimulate domestic demand and increase China's economic development capacity, the country must shift the tax system from production-based to consumption-based, Jin says.

However, fluctuations in the macroeconomic situation always become obstacles to tax reform.

As early as 1998, economists proposed tax-system reforms, because, at that time, China's economy grew at a relatively low rate, as a result of the Asian financial crisis.

The economists believed the reform would help improve the tax system and stimulate economic growth.

But the government worried the reform would result in lost fiscal revenues.

The government needed money to solve some prominent issues, such as unemployment, social instability and the reform of State-owned companies.

The government decided not to change the system.

The Chinese economy, in 2003, entered a new development period. But the government faced new problems.

China's fixed-asset investment, fuelled by expansion of sectors such as steel and cement, began growing at a rapid pace.

The government worried fast fixed-asset investment would result in an overheated economy.

This situation forced the government to delay trial reform of the tax system from the beginning of last year to the second half of the year.

The content of the reform was also revised. Only newly purchased machinery equipment in eight industries including auto manufacturing and machinery making in the three provinces could qualify for the value-added tax rebate.

Peng Longyun, a senior economist with the Asian Development Bank, says under the present macroeconomic situation, the government could delay spreading the reform until the second half of next year.

"The economy is far from achieving a soft landing," he says.

During the first four months of this year, China's urban fixed-asset investment grew 25.7 per cent, year-on-year.

Growth of fixed-asset investment was still strong, Peng says.

"It shows no sign of weakening," he says. "The size of investment is also still too large."

Although the government's macro-control measures achieved some results, they were not very effective, he says.

The government also needs money to cover the losses resulting from the tax reform, since it did not arrange the amount of expenditure in its annual budget.

"There is no sign the government will spread the reform this year," he says.

It is also unlikely the government will spread the reform in the first half of next year, since the National People's Congress needs to review the issue in March, he says.

Jia Kang, a senior researcher with the Institute of Fiscal Science under the Ministry of Finance, says the government should seize the current opportunity to reform the existing tax system including the value-added tax and the enterprise income tax.

China is still enjoying fast growth of its fiscal revenues.

"This will be a strong guarantee for the tax reform, which will result in a loss of tax revenues," he says.

Jin says the present macroeconomic situation and fears of lost fiscal revenues should not be obstacles to the tax-system reform.

The reform will not have a negative impact on macro control, since investments in red-hot sectors will not be eligible for rebates, he says.

Companies will also consider investment risks when making investments, he says.

As for revenue losses, the government can bear the cost, he says.

When companies become rich, they will contribute more to the State's revenues, he says.

Jin says reforming the tax will help reduce companies' financial burdens. The country's fiscal revenues are likely to fall about 150 billion yuan (US$18 billion) each year, in accordance with the present investment scale.

(China Daily 06/20/2005 page4)