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Personal income tax is an issue of direct concern to many， and is always a major focus at each year’s sessions of the National People’s Congress （NPC） and the National Committee of the Chinese People’s Political Consultative Conference. This year， in his Report on the Work of the Government delivered to the First Session of the 13th NPC on March 5， Premier Li Keqiang revealed that China will raise the threshold for personal income tax.
Over the past fi ve years， China’s per-capita disposable income has been growing 7.4 percent every year， reaching 25，974 yuan（$4，033） in 2017. Yet the personal income tax threshold has remained at the 3，500-yuan（$552.92） level set seven years ago. Raising the tax threshold will be of great benefit to many of China’s citizens.
In 2014， with the start of the ongoing tax reform， the Ministry of Finance （MOF） listed six major areas for reform， namely the conversion of business tax to value-added tax， the introduction of environment and property taxes， and the revision of resource， consumption and personal income taxes. Among these， reform of the personal income tax is regarded as the hardest nut to crack after the notably complicated property tax.
Personal income tax is a vital channel through which to reallocate incomes and promote social fairness. “High-income earners pay higher taxes while low-income earners pay less or no taxes” is the principle underpinning fairness in systems of taxation. Yet merely raising the tax threshold could have adverse results under China’s current policy. For instance， if the tax threshold is raised to 10，000 yuan （$1，579.78）， one whose monthly income is 7，000 yuan（$1，105.85） will enjoy a tax reduction of 90 yuan （$14.22）， while one who earns 20，000 yuan （$3，159.56） a month will enjoy a reduction of 1，400 yuan （$221.17）. This means that the high-income group would actually enjoy greater benefi ts from tax reduction.
It was pleasing to see that at a press conference on tax reform and fiscal work held on March 7， then Minister of Finance Xiao Jie not only explained the possible changes to the personal income tax threshold and tax reduction items， but also vowed to reform and improve the pattern of collecting tax and establish a system combining comprehensive and classifi ed taxation.
Major defects
Currently individuals in China are taxed on their income by category. The Individual Income Tax Law groups personal income into 11 categories， including employment income， payment for labor services， author’s remuneration， interest， dividends and profit distribution， and income from the operation of sole proprietorship. Each category has its own tax rates and allowable deductions. For instance， the calculation of personal income tax on monthly employment income is based on seven progressive tax rates after the deduction of the tax threshold； for income derived from labor services， personal income tax is calculated based on three progressive tax rates ranging from 20 to 40 percent； and a fl at actual rate of 14 percent is applied to author’s remuneration. An individual’s income tax liability is borne by the employer or the institution providing income. Such a tax system， one defined by low cost and high efficiency， was well-suited to China’s employment conditions during the initial stage of reform and opening up. However， as China enters a new economic phase characterized by higher incomes， this classified income tax system has begun to encounter problems.
First of all， the function of income reallocation is limited. Although the value of personal income tax has grown rapidly in recent years， it accounted for only 7 percent of China’s total tax revenue in each of the past fi ve years， with the proportion steady at around 5-7 percent over the past three decades. In terms of the share of the country’s GDP， the personal income tax has less than 1.5 percent. The current rates of personal income tax are not what would be considered low， indicating that there are structural problems in the tax system. The benefi ts of income redistribution through taxation are thus inadequate.
Moreover， deduction standards are unreasonable. The tax threshold， which serves as the basic deduction standard， is not subject to a regular adjustment mechanism as resident income and price levels change. In addition to this， deduction standards are uniform across the country regardless of the huge gaps in actual living costs between different regions. As the income of all family members and expenses on education， supporting parents and housing differ greatly from place to place， residents of a similar income have quite different capacities for paying tax depending on where they live.
The structure of tax rates and tax items are currently too complicated. Different tax collection patterns and progressive tax rates are applied to the 11 categories of income. This sometimes presents inequity for groups of a similar pay but with different sources of income. Even more seriously， high-income groups with multiple sources of earnings can easily evade tax by changing tax items or splitting incomes. In contrast， someone with a low income from a single source may ultimately pay higher taxes.
Worse still， marginal tax rates affect China’s competitiveness in attracting international talent. Competition among countries to attract the most innovative minds is becoming increasingly fi erce， so in determining a tax policy the government has to consider not only domestic income reallocation， but also the personal income tax policies of other countries. In China， the marginal tax rate for employment income is 45 percent， while that for income derived from labor services is 40 percent， higher than the average marginal tax rates in developed countries. Increasing the competitiveness of China’s personal income tax will make China more appealing to overseas professionals. Finally， the tax collection and administration system is not yet wide-ranging enough. At present， Chinese people’s sources of income， especially among high-income groups， are diversified and not sufficiently transparent. Information on personal incomes is poorly shared between different regions and departments， so the taxation authority has no comprehensive system of supervision and the individual income tax liability is mainly borne by employers or institutions providing income. Taxes from wages and salaries account for 65 percent of the total personal income tax revenue， with most off-payroll incomes going untaxed.
Means of reform
According to the press conference on March 7， it is clear that the reform of personal income tax will focus on solving the existing problems through a series of potential measures.
The amendment of the Individual Income Tax Law may merge some of the current 11 categories of incomes. For instance， one category may be income generated from labor， including wages and salaries， income from labor services and author’s remuneration. Another category might constitute earnings generated from property， including income from the operation of sole proprietorship， income from the operation of a business on a contract or lease basis， income from franchise fees， interest， dividends and profi t distribution， rental income and income from the transfer of property. Incident income and other taxable income could also become a new category.
Meanwhile， improvements can also be made to the pre-tax deduction system， composed of basic deduction and special deduction. At present， pre-tax deduction includes basic pension insurance， medical and unemployment insurance， provident funds as well as occupational pensions， supplementary pensions and commercial medical insurance within a certain limit. One signifi cant indicator of progress made during the ongoing reform is that special deduction has been added， such as expenditure on supporting parents， critical illnesses and the education of children. There are also appeals for expenditure on housing loan interests， personal career development and on-thejob training to be deductible from taxable income.
Calls are growing for the tax threshold to be adjusted flexibly in accordance with changing prices and infl ation so as to reduce the influence of economic fluctuations on people’s living standards. Others also suggest different tax thresholds for different regions. It is likely that the structure of tax rates will be attuned. Based on the current tax structure， the marginal tax rate should be properly adjusted， progressive tax rates simplified and tax rates applied to different categories of income reasonably set.
Family expenditure declaration may also be introduced. Comprehensive familybased income declaration may be diffi cult to realize in the short term because of broader changes in family structure and corresponding family income patterns in China， but the country can first allow joint declaration by couples for expenditure on supporting parents， the education of children and housing loan interests， to determine how this expenditure should be deducted.
As part of an effective tax collection and administration system， the government should establish a tax-related information sharing network among different regions and departments. A system of individual income and property information should also be set up.
China’s personal income tax system has been reformed three times—in 2005， 2007 and 2011—since the Individual Income Tax Law was promulgated in 1980. The procedures for reform are thus mature， and it will be easy to reach societal consensus on the necessary restructuring. The tax threshold should be raised as soon as possible， with other measures of personal income tax reform implemented step by step， with the aim of establishing a stable tax structure and a tax threshold which is adjusted on a regular basis.
Over the past fi ve years， China’s per-capita disposable income has been growing 7.4 percent every year， reaching 25，974 yuan（$4，033） in 2017. Yet the personal income tax threshold has remained at the 3，500-yuan（$552.92） level set seven years ago. Raising the tax threshold will be of great benefit to many of China’s citizens.
In 2014， with the start of the ongoing tax reform， the Ministry of Finance （MOF） listed six major areas for reform， namely the conversion of business tax to value-added tax， the introduction of environment and property taxes， and the revision of resource， consumption and personal income taxes. Among these， reform of the personal income tax is regarded as the hardest nut to crack after the notably complicated property tax.
Personal income tax is a vital channel through which to reallocate incomes and promote social fairness. “High-income earners pay higher taxes while low-income earners pay less or no taxes” is the principle underpinning fairness in systems of taxation. Yet merely raising the tax threshold could have adverse results under China’s current policy. For instance， if the tax threshold is raised to 10，000 yuan （$1，579.78）， one whose monthly income is 7，000 yuan（$1，105.85） will enjoy a tax reduction of 90 yuan （$14.22）， while one who earns 20，000 yuan （$3，159.56） a month will enjoy a reduction of 1，400 yuan （$221.17）. This means that the high-income group would actually enjoy greater benefi ts from tax reduction.
It was pleasing to see that at a press conference on tax reform and fiscal work held on March 7， then Minister of Finance Xiao Jie not only explained the possible changes to the personal income tax threshold and tax reduction items， but also vowed to reform and improve the pattern of collecting tax and establish a system combining comprehensive and classifi ed taxation.
Major defects
Currently individuals in China are taxed on their income by category. The Individual Income Tax Law groups personal income into 11 categories， including employment income， payment for labor services， author’s remuneration， interest， dividends and profit distribution， and income from the operation of sole proprietorship. Each category has its own tax rates and allowable deductions. For instance， the calculation of personal income tax on monthly employment income is based on seven progressive tax rates after the deduction of the tax threshold； for income derived from labor services， personal income tax is calculated based on three progressive tax rates ranging from 20 to 40 percent； and a fl at actual rate of 14 percent is applied to author’s remuneration. An individual’s income tax liability is borne by the employer or the institution providing income. Such a tax system， one defined by low cost and high efficiency， was well-suited to China’s employment conditions during the initial stage of reform and opening up. However， as China enters a new economic phase characterized by higher incomes， this classified income tax system has begun to encounter problems.
First of all， the function of income reallocation is limited. Although the value of personal income tax has grown rapidly in recent years， it accounted for only 7 percent of China’s total tax revenue in each of the past fi ve years， with the proportion steady at around 5-7 percent over the past three decades. In terms of the share of the country’s GDP， the personal income tax has less than 1.5 percent. The current rates of personal income tax are not what would be considered low， indicating that there are structural problems in the tax system. The benefi ts of income redistribution through taxation are thus inadequate.
Moreover， deduction standards are unreasonable. The tax threshold， which serves as the basic deduction standard， is not subject to a regular adjustment mechanism as resident income and price levels change. In addition to this， deduction standards are uniform across the country regardless of the huge gaps in actual living costs between different regions. As the income of all family members and expenses on education， supporting parents and housing differ greatly from place to place， residents of a similar income have quite different capacities for paying tax depending on where they live.
The structure of tax rates and tax items are currently too complicated. Different tax collection patterns and progressive tax rates are applied to the 11 categories of income. This sometimes presents inequity for groups of a similar pay but with different sources of income. Even more seriously， high-income groups with multiple sources of earnings can easily evade tax by changing tax items or splitting incomes. In contrast， someone with a low income from a single source may ultimately pay higher taxes.
Worse still， marginal tax rates affect China’s competitiveness in attracting international talent. Competition among countries to attract the most innovative minds is becoming increasingly fi erce， so in determining a tax policy the government has to consider not only domestic income reallocation， but also the personal income tax policies of other countries. In China， the marginal tax rate for employment income is 45 percent， while that for income derived from labor services is 40 percent， higher than the average marginal tax rates in developed countries. Increasing the competitiveness of China’s personal income tax will make China more appealing to overseas professionals. Finally， the tax collection and administration system is not yet wide-ranging enough. At present， Chinese people’s sources of income， especially among high-income groups， are diversified and not sufficiently transparent. Information on personal incomes is poorly shared between different regions and departments， so the taxation authority has no comprehensive system of supervision and the individual income tax liability is mainly borne by employers or institutions providing income. Taxes from wages and salaries account for 65 percent of the total personal income tax revenue， with most off-payroll incomes going untaxed.
Means of reform
According to the press conference on March 7， it is clear that the reform of personal income tax will focus on solving the existing problems through a series of potential measures.
The amendment of the Individual Income Tax Law may merge some of the current 11 categories of incomes. For instance， one category may be income generated from labor， including wages and salaries， income from labor services and author’s remuneration. Another category might constitute earnings generated from property， including income from the operation of sole proprietorship， income from the operation of a business on a contract or lease basis， income from franchise fees， interest， dividends and profi t distribution， rental income and income from the transfer of property. Incident income and other taxable income could also become a new category.
Meanwhile， improvements can also be made to the pre-tax deduction system， composed of basic deduction and special deduction. At present， pre-tax deduction includes basic pension insurance， medical and unemployment insurance， provident funds as well as occupational pensions， supplementary pensions and commercial medical insurance within a certain limit. One signifi cant indicator of progress made during the ongoing reform is that special deduction has been added， such as expenditure on supporting parents， critical illnesses and the education of children. There are also appeals for expenditure on housing loan interests， personal career development and on-thejob training to be deductible from taxable income.
Calls are growing for the tax threshold to be adjusted flexibly in accordance with changing prices and infl ation so as to reduce the influence of economic fluctuations on people’s living standards. Others also suggest different tax thresholds for different regions. It is likely that the structure of tax rates will be attuned. Based on the current tax structure， the marginal tax rate should be properly adjusted， progressive tax rates simplified and tax rates applied to different categories of income reasonably set.
Family expenditure declaration may also be introduced. Comprehensive familybased income declaration may be diffi cult to realize in the short term because of broader changes in family structure and corresponding family income patterns in China， but the country can first allow joint declaration by couples for expenditure on supporting parents， the education of children and housing loan interests， to determine how this expenditure should be deducted.
As part of an effective tax collection and administration system， the government should establish a tax-related information sharing network among different regions and departments. A system of individual income and property information should also be set up.
China’s personal income tax system has been reformed three times—in 2005， 2007 and 2011—since the Individual Income Tax Law was promulgated in 1980. The procedures for reform are thus mature， and it will be easy to reach societal consensus on the necessary restructuring. The tax threshold should be raised as soon as possible， with other measures of personal income tax reform implemented step by step， with the aim of establishing a stable tax structure and a tax threshold which is adjusted on a regular basis.