Time for a tax cut

China’s finance minister proposes income tax reforms

He Lifeng, director of the NDRC, attends a news conference on the sidelines of China's National People's Congress in Beijing

He Lifeng: bullish on consumption

Income tax was first introduced to the United Kingdom in 1799 as a means to raise funds for the war against Napoleon. In America, it was legalised by Congress in 1913 and by the final year of the First World War the top rate of tax had been set at 77%. As China heads for a trade conflict with the US, it seems to be reassessing its policies on income tax too.

The main proposal in Beijing’s review is that people earning less than Rmb5,000 per month (about $9,300 a year) shouldn’t pay any tax. Currently citizens are taxed on earnings above Rmb3,500 a month, but a draft proposal submitted to the Standing Committee of the National People’s Congress last week recommended raising the bar to the higher amount. The move is designed to “increase consumer spending” and offer “leeway for future growth” said Liu Kun, minister of finance.

Domestic consumption is an increasingly important driver of the national economy. He Lifeng, chairman of the National Development and Reform Committee, estimated in March that it will contribute more than 60% of economic growth this year. During the first quarter, retail sales (a key metric of consumer spending) grew 9.8%, a slower rate than for the same period last year. In May growth was just 8.5%, the slowest since June 2003, the South China Morning Post says.

With industrial profits also set to take a hit from American tariffs, the government needs to encourage stronger consumption at home. But the proposed amendments to income tax aren’t simply a response to the trade disputes. While international media has highlighted that the tax break is the first significant adjustment in seven years, it can also be understood in terms of Beijing’s Five-Year Plans. The last major amendment was made during the 12th Five-Year Plan (2011-2015), which specifically called for the minimum allowance on income tax to be raised. It was – from Rmb2,000 a month to the current Rmb3,500 a month. And now the threshold seems set for adjustment upwards by the same amount again.

Although the current planning document didn’t explicitly call for an increase in the thresholds, it did pledge to “increase the earnings of low-income earners and increase the proportion of middle-income earners”.

According to Li Wanfu, head of the institute of tax science at the State Administration of Taxation, the reforms will do just that.

“The personal income tax reform is primarily good news for middle to lower income groups as people with less income will see a larger tax reduction,” he told Xinhua.

However, Xinhua reported that tax contributions could also be cut by up to 50% for those earning Rmb20,000 to Rmb80,000 a month, or people more in the “high earner” category.

The proposed reforms also introduce tax deductibles for the first time, which Bloomberg reckons will benefit higher-earners most. The deductions would be applicable to spending on items such as education, medical treatment and mortgage interest repayments, and reflect a response to middle-class complaints that disposable incomes aren’t growing at the same pace as living costs.

Reducing tax avoidance is another target of the reforms. Under the current laws there are 11 categories for classifying income, which has allowed people with multiple sources of income to game the system. The new tax plan would merge many of those categories and the bill would also introduce more detailed guidelines for punishing avoidance – something that was largely absent before.

The central government has room for maneouvre on the reforms because the state is bankrolled mostly by corporate and sales taxes. Individual income taxes contributed about 6.6% of the Rmb900 billion collected in 2015, according to government data.

Revenues from income tax have also been rapidly increasing, providing more room for cuts.

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