Helping those 'who never had it so good'

With China's economy slowing down, some economists once again call on to levy the personal income tax based on family revenue to accelerate boosting consumption.

No doubt to ease the tax burden will be helpful. If the 20-something generation "never had it so good" as children, now they have started their working lives, the reverse is definitely the case. They have to spend heavily on educating their own children, mortgages for their homes and looking after parents and grandparents. The biggest burden of all is their own and their parents' expectations as to their standard of living and the hopes of the government that they can be the engine of a domestic consumption boom that can transform the economy.

There has been considerable debate in the press over the extent to which reform of the individual income tax system may help ease the weight of these obligations, while still encouraging the sense of individual responsibility for which the Chinese are rightly renowned. In many developed countries we have seen the development of the tax system to provide a number of different incentives. These include vouchers to help lower the cost of child care for women returners to work, tax allowances to encourage contributions to individual pensions so as to reduce the burden on the State system, and tax credits to provide real additional income from working rather than remaining unemployed.

These incentives are not without their critics. In particular the tax allowances for contributions to private pensions have been criticized for providing too big an allowance for the better-off and not providing sufficient incentive for low income groups to participate. Other tax-related incentives have been abolished because of the distortions to the economy such as those we had in the United Kingdom for mortgage interest payments and for married couples. But the problems of using such incentives in China are far wider and go to the heart of why China is still a developing and not a fully developed economy.

The first is that most Chinese workers remain outside the tax system. Approximately 10 percent of the entire Chinese workforce pay income tax and their income taxes contribute roughly 5 percent of total state revenues. So any tax-based incentives will only affect a relatively small proportion of the working population, and by no means the poorest section at that. The second reason is administrative complexity. This is a big enough problem in the UK as the recent restrictions on the payment of child benefit illustrate. Two years ago the UK government decided that from 2013 anyone earning income over the top rate of tax, roughly the equivalent of 420,000 yuan ($66,683) a year would completely lose eligibility for child benefit. However it was quickly realized that if a couple had independent incomes of 400,000 yuan each, they would retain the benefit in full. The result of course was a large public outcry. The reason why the government couldn't provide a household rather than an individual income limit, is that there is no information held in the tax system to link couples together. The government is now scrambling to mitigate this problem, but the damage to its credibility on this issue has been done.

If this problem can happen in the UK with a population of only 60 million, a unified tax and social security system, and linked up government databases, imagine the problems such incentives would cause in China. The key administrative organs are differently organized, the State Administration of Taxation on a vertical basis and those for social security, public security and health on a local. Even the different organs themselves have a large number of different IT systems that don't "talk" to each other and the bodies themselves are often very protective of the information they hold. Quite simply, a complicated system of tax incentives and allowances is not feasible for a long time to come, and if implemented would be subject to a high and substantial risk of fraud.

That does not mean some individual tax reforms would not be beneficial. One important change would be to reduce the number of tax bands and widen the income limits as the Research Institute of Fiscal Science recommended last year. This would reduce the complexity of the system and high marginal tax rates for those middle-income earners benefiting from China's growth. The second change would be to automatically index the tax bands to the rate of inflation every year. The allowance for the lowest bands could perhaps incorporate a higher weighting for food inflation.

On the benefit side, the simplest and most effective benefit would be a flat rate child allowance. This is attractive for China because it can be limited to the child, it can be paid to the mother, whether within or outside the tax system, by the government of her hukou area and its payment can be triggered through the registration of the child's birth certificate. As a flat rate benefit it would have a significant progressive impact and it would be time limited. The only real fraud issue would be stopping benefit if a child died, but periodic re-registration could help with that.

On the wider issue, the money for supporting China's increasing social needs can only be met from higher contributions from enterprises, particularly the State-owned enterprises and from a redistribution of spending away from large infrastructure projects to providing services that address growing social needs. But that is another story.

The author is an international financial consultant based in Kuala Lumpur and former fund management expert on the EU-China Social Security Project.

(China Daily 07/03/2012 page9)