Government Edges toward Promised Tax Reform
(Beijing) – Top policymakers have signaled a willingness to take new and concrete steps toward reducing business taxes in China, fueling expectations for what could be long-promised tax reforms in 2016.
These expectations stem from interpretations of tax policy statements released in December at the Central Economic Work Conference, an annual policy-setting event attended by top central government and Communist Party officials, said Ji Dongsheng, deputy director of the Revenue Scientific Research Institute, a unit of the State Administration of Taxation.
The work conference statements featured expressions never before seen in government tax policy documents. They replaced the more common wording repeated by conference reports in past years.
One document cited plans to "study reducing" the nationwide value-added tax (VAT) paid by manufacturers. Work conferences in the past often mentioned "structural tax reductions" – a vague expression that essentially boiled down to little or no tax-cutting action.
The shift in wording "shows there will be an institutional design for reducing taxes," Ji said, "not just an announcement of tax-cut policies."
The changes in wording also indicate that the government's tax reform focus has shifted from broad plans for cutting the scope of nationwide taxation to spelling out concrete measures that actually reduce tax levies, according to Ji.
In addition to taking aim at the VAT, policymakers are mulling new fund-raising methods such as property taxes and following through with tax reform measures introduced in 2012 and 2014 that have yet to be fully implemented.
A long-discussed national framework for locally levied property taxes would provide new revenue sources for local governments, making it easier for them to cope with treasury-straining tax cuts in other areas. Until now, though, property taxes have been introduced in only Shanghai and Chongqing on a trial basis.
The central government has pledged to expand the pilot of property tax, but has yet to implement. These property taxes would be offset by cuts in the fees collected by the government on property transactions.
Jia Kang, former director of the Ministry of Finance's Research Institute for Fiscal Science, said recently that policymakers are still debating whether or not now would be the wrong time for a property tax system, given the nation's sluggish housing market.
Also on the reform agenda are proposed changes for the ways that natural resources such as coal and other minerals are taxed. Taxes on resource extraction activities would be based on a target resource's price rather than the volume of materials taken from the ground.
Rates for nationwide sales taxes would be adjusted, too, according to sources close to policymakers. Sales tax revenues, which are currently funneled into central government coffers, would be shared by central and local governments.
Moreover, people with knowledge of the matter said that tax administrators have introduced a general plan aimed at improving the nation's personal income tax in ways designed to give equal treatment to poor and rich taxpayers. A draft plan for this proposal is likely to be submitted to the State Council for review before July.
Slow Process
In 2012, the government started phasing in a business-friendly program that would replace business taxes with VAT, with the goal of full implementation by 2015. A more comprehensive reform plan for property taxes, resource taxes and streamlining the system for distributing tax revenues among local and central governments was introduced in 2014, and was to be finished by the end of 2016.
The finance ministry estimated in 2012 that the shift to VAT from business taxes alone would reduce total tax collections by at least 900 billion yuan. By June 2015, according to the state taxation office, the program's had been phased in to the point where total tax revenues had been reduced by 485 billion yuan.
The government purposely missed its deadline for shifting from the business tax to VAT in order to shore up its revenue stream, which has been bringing in less than planned since 2013 due to a nationwide slowdown for economic growth. So far, the shift has yet to affect building construction companies, financial services firms and other businesses in the service sector.
Plans to phase-in property taxes have faced similar hurdles. One of the government's reasons for hesitating was explained in April 2015 by the finance minister, Lou Jiwei, who said at a conference that changing the system for taxing property owners and construction businesses would hurt government revenues.
Legislation needed to carry out plans for a new environment tax on polluters and revise overall tax administration laws are still being discussed by members of the State Council.
A draft version the environmental protection tax law was released for public comment in June by the tax administration and the Ministry of Environmental Protection. Su Ming, deputy director at the Research Institute for Fiscal Science, a unit of the Ministry of Finance, said fine-tuning of the environmental protection tax law is likely to be finished in 2016. The tax would replace the current system of collecting pollution fees based on administrative orders on companies' emission activities, Su said.
Business taxes are a major revenue source for local governments. Phasing out the tax and phasing in VAT could reduce their revenues, since VAT funds are to be shared by local and central governments. How the funds would be shared has been the subject of disagreements between local and central government officials.
Xu Shanda, a former deputy director of the state tax administration, said changes to the tax system made so far have cut local government revenues.
Total fiscal revenues for the all governments nationwide rose 8.6 percent between 2013 and the following year, which was the lowest year-on-year growth rate since 1992. The rate further declined to 5.7 percent in the first 11 months of 2015, compared to the same period 2014. Some provinces, such as Liaoning in the northeast and Shanxi in the north-central part of the country, have reported government budget deficits.
A tax administration official in Beijing said that if economic growth continues to lose steam in 2016, tax reform policies will be increasingly difficult to implement. Businesses are closely monitoring the situation while hoping the government's promises of tax cuts will be fulfilled.
Striking a Balance
Zhang Xuedan, a tax policy expert who works for the Ministry of Finance, is more cautious about the prospects for full reform in 2016. "Whether there will be concrete tax cut will depend on whether new tax policies are issued," he said.
Zhang said sales, resource and property tax proposals if implemented together actually increase the overall taxpayer burden. Yet the central government is under pressure to help businesses improve their bottom line by lowering tax costs.
Striking a balance between tax cuts and government revenue needs is not easy, Xu said, as a bad move could open up "tax deduction loopholes and flaws in the entire taxation system."
Because of the complexity of reforms, one finance official with a local government who asked not to be named said more than a year would be needed to complete a business tax-to-VAT conversion.
As the conversion unfolds, authorities are applying different VAT rates, ranging from zero to 17 percent, to different kinds of businesses. Zhang said the tax structure eventually should be revamped so that there are only two rates – a basic rate and a preferential rate.
Some tax experts have suggested the government set the basic VAT rate at around 15 percent. But Zhang said the final rate will be determined by policymakers based on government revenue needs and how tax funds are shared by the central and local governments.
These expectations stem from interpretations of tax policy statements released in December at the Central Economic Work Conference, an annual policy-setting event attended by top central government and Communist Party officials, said Ji Dongsheng, deputy director of the Revenue Scientific Research Institute, a unit of the State Administration of Taxation.
The work conference statements featured expressions never before seen in government tax policy documents. They replaced the more common wording repeated by conference reports in past years.
One document cited plans to "study reducing" the nationwide value-added tax (VAT) paid by manufacturers. Work conferences in the past often mentioned "structural tax reductions" – a vague expression that essentially boiled down to little or no tax-cutting action.
The shift in wording "shows there will be an institutional design for reducing taxes," Ji said, "not just an announcement of tax-cut policies."
The changes in wording also indicate that the government's tax reform focus has shifted from broad plans for cutting the scope of nationwide taxation to spelling out concrete measures that actually reduce tax levies, according to Ji.
In addition to taking aim at the VAT, policymakers are mulling new fund-raising methods such as property taxes and following through with tax reform measures introduced in 2012 and 2014 that have yet to be fully implemented.
A long-discussed national framework for locally levied property taxes would provide new revenue sources for local governments, making it easier for them to cope with treasury-straining tax cuts in other areas. Until now, though, property taxes have been introduced in only Shanghai and Chongqing on a trial basis.
The central government has pledged to expand the pilot of property tax, but has yet to implement. These property taxes would be offset by cuts in the fees collected by the government on property transactions.
Jia Kang, former director of the Ministry of Finance's Research Institute for Fiscal Science, said recently that policymakers are still debating whether or not now would be the wrong time for a property tax system, given the nation's sluggish housing market.
Also on the reform agenda are proposed changes for the ways that natural resources such as coal and other minerals are taxed. Taxes on resource extraction activities would be based on a target resource's price rather than the volume of materials taken from the ground.
Rates for nationwide sales taxes would be adjusted, too, according to sources close to policymakers. Sales tax revenues, which are currently funneled into central government coffers, would be shared by central and local governments.
Moreover, people with knowledge of the matter said that tax administrators have introduced a general plan aimed at improving the nation's personal income tax in ways designed to give equal treatment to poor and rich taxpayers. A draft plan for this proposal is likely to be submitted to the State Council for review before July.
Slow Process
In 2012, the government started phasing in a business-friendly program that would replace business taxes with VAT, with the goal of full implementation by 2015. A more comprehensive reform plan for property taxes, resource taxes and streamlining the system for distributing tax revenues among local and central governments was introduced in 2014, and was to be finished by the end of 2016.
The finance ministry estimated in 2012 that the shift to VAT from business taxes alone would reduce total tax collections by at least 900 billion yuan. By June 2015, according to the state taxation office, the program's had been phased in to the point where total tax revenues had been reduced by 485 billion yuan.
The government purposely missed its deadline for shifting from the business tax to VAT in order to shore up its revenue stream, which has been bringing in less than planned since 2013 due to a nationwide slowdown for economic growth. So far, the shift has yet to affect building construction companies, financial services firms and other businesses in the service sector.
Plans to phase-in property taxes have faced similar hurdles. One of the government's reasons for hesitating was explained in April 2015 by the finance minister, Lou Jiwei, who said at a conference that changing the system for taxing property owners and construction businesses would hurt government revenues.
Legislation needed to carry out plans for a new environment tax on polluters and revise overall tax administration laws are still being discussed by members of the State Council.
A draft version the environmental protection tax law was released for public comment in June by the tax administration and the Ministry of Environmental Protection. Su Ming, deputy director at the Research Institute for Fiscal Science, a unit of the Ministry of Finance, said fine-tuning of the environmental protection tax law is likely to be finished in 2016. The tax would replace the current system of collecting pollution fees based on administrative orders on companies' emission activities, Su said.
Business taxes are a major revenue source for local governments. Phasing out the tax and phasing in VAT could reduce their revenues, since VAT funds are to be shared by local and central governments. How the funds would be shared has been the subject of disagreements between local and central government officials.
Xu Shanda, a former deputy director of the state tax administration, said changes to the tax system made so far have cut local government revenues.
Total fiscal revenues for the all governments nationwide rose 8.6 percent between 2013 and the following year, which was the lowest year-on-year growth rate since 1992. The rate further declined to 5.7 percent in the first 11 months of 2015, compared to the same period 2014. Some provinces, such as Liaoning in the northeast and Shanxi in the north-central part of the country, have reported government budget deficits.
A tax administration official in Beijing said that if economic growth continues to lose steam in 2016, tax reform policies will be increasingly difficult to implement. Businesses are closely monitoring the situation while hoping the government's promises of tax cuts will be fulfilled.
Striking a Balance
Zhang Xuedan, a tax policy expert who works for the Ministry of Finance, is more cautious about the prospects for full reform in 2016. "Whether there will be concrete tax cut will depend on whether new tax policies are issued," he said.
Zhang said sales, resource and property tax proposals if implemented together actually increase the overall taxpayer burden. Yet the central government is under pressure to help businesses improve their bottom line by lowering tax costs.
Striking a balance between tax cuts and government revenue needs is not easy, Xu said, as a bad move could open up "tax deduction loopholes and flaws in the entire taxation system."
Because of the complexity of reforms, one finance official with a local government who asked not to be named said more than a year would be needed to complete a business tax-to-VAT conversion.
As the conversion unfolds, authorities are applying different VAT rates, ranging from zero to 17 percent, to different kinds of businesses. Zhang said the tax structure eventually should be revamped so that there are only two rates – a basic rate and a preferential rate.
Some tax experts have suggested the government set the basic VAT rate at around 15 percent. But Zhang said the final rate will be determined by policymakers based on government revenue needs and how tax funds are shared by the central and local governments.
