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Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

Tax Burdens in China

Prof. Dashu Wang1 Peking University



Since the 1980s, many countries in the world have enacted or are considering tax reforms. Although they have widely varying tax systems, some common themes most notably, the attempt to lower tax rates run through most of these reforms. There are abundant studies on cases of developed and developing countries in relation to tax reform. Indeed, one of the economic objectives in many countries has been a reduction in both personal as well as corporate tax rates along with the broadening of the tax base. With the more recent interest in growth theory and alternative economic policies that may result in economic growth, some economists have concentrated their attention on the effect of tax reform on economic growth (see Engen and Skinner [1999]). Indeed, the relationship between tax reform and economic growth has been a widely addressed subject in growth literature.

Research in this area began in developed countries, particularly within the US. Scully

Correspondence to:

Prof. Dashu Wang School of Economics Peking University Beijing P.R. CHINA Email: dashuwang@yahoo.com

Wang, D., Tax Burdens in China.


Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

(1988) shows that governmental institutional obstacles e.g., substantial regulations, restrictions on imports along with taxes, hurt growth. This early research became increasingly accepted as new refinements and extensions of the tax-growth literature continued into the new century. In recent study (Gittell, Kaufman and Karson 2000), the authors explore regional and state patterns in US economic change, concluding that the role of geography itself is modest in explaining differentials but that other factors, including state personal income taxes, play a more important role. A study by Public Interest Institute of the US (2003) finds that states that exempted capital gains had higher rates of economic growth than states with high capital gains taxes, and that states that cut income taxes in the 1990s had high growth rates than states that raised taxes.

The studies using US data are confirmed by numerous international studies. For example, speaking of government taxation, a Spanish economist (de la Fuente 1997) concludes that there is evidence of a sizable negative externality effect on the level of productivity. Italian economists Tabellini and Daveri (1997) argue that the increase in European unemployment and economic slowdown are caused by an excessively high cost of labor, which is generated by, among other things, higher taxes on labor. Using a complex general equilibrium model, German economist Heitger (1993) states that for the most OECD countries, taxation turns out to be growth-retarding. Fougeres (1998) work on Canada shows adverse effects of taxes on growth, both impacting on supply and demand. Scully (1996) concludes that New Zealand would have to cut its taxes roughly in half to maximize its economic growth, and that the marginal cost of taxation is $2.64 for each extra dollar of taxes collected.

Tax reform also constitutes one of the core areas of recent economic reform programs in developing countries. Chelliah (1975) has presented a comprehensive analysis of taxation trend in developing countries. A number of researchers have presented some case studies in this area. For example, Gordon (1990) discusses reforms of explicit

Wang, D., Tax Burdens in China.


Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

and implicit taxes in China; McLure (1990) considers tax reform in an inflationary environment in Colombia; Gillis (1990), looks at tax reform in Indonesia; Diaz (1990) presents a historical overview of tax policy goals in Mexico.

Benson and Johnson (1986) show that taxes have lagged negative effects, with the adverse impact being realized often after about three years. Some researchers concentrate on the relationship between tax structure and the economic structure as related to the level of economic development (see, Abizadeh [1979] and Chelliah [1989]). Utilizing new tax burden indexes, Pillarisetti (2002) argues that a flat or zero income tax creates pro-growth initiatives, reduces corruption and the size of informal sectors and generates overall institutional improvements in low income countries.

Since 1994 when China reformed its tax system, its tax revenues have rapidly grown. According to the statistics from the State Administration of Taxation (SAT), tax revenues in 2002 were 1700 billion yuan, more than doubling those in 1997 (823 billion yuan), and the ratio of tax over GDP was 16.7%. In 1998-2002, tax revenues accumulated to 6423 billion yuan, more than the total revenues in 1949-1997 by 661 billion yuan. In 2002, Jin Renqing, the then head of SAT, stated that the five years from 1998 to 2002 were the best since the establishment of new China, because tax revenues had rapidly grown, and the role of tax policy had functioned well.

It is beyond debate that China has enjoyed a rapid growth in tax revenues, but it is controversial whether its tax burden is too heavy or not. On the one hand, An Tifu (2002) and Gao Peiyong (2002) argue that the tax burden is too heavy; on the other hand, Guo Wenxuan et al. (2002) hold that tax revenues are not adequate. The purpose of this paper is to present a general picture of the tax burden in China and from the tax/GDP ratio to analyze the factors which influence the tax burdens.

Wang, D., Tax Burdens in China.


Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)


Tax Rates

The current tax structure in China was established in 1994. During that time, its tax administration and collection were inefficient. In order to maintain enough revenue the authorities deliberately set higher tax rates. This section presents examples in the areas of important sectors in Chinese economy such as agriculture, industry, service, individuals and business.

Most, if not all, countries in the world do not collect agricultural tax. It is interesting to note that many countries levy a negative tax on agriculture, that is, they allocate special funds to subsidize farmers. For example, the US and Japan spend a huge quantity of money to subsidize agricultural producers. However, China is the exception, along with a few other countries. According to the Regulations of Agriculture Tax, the national average rate on agricultural products is 15.5% of the yield in a normal year, and the currently implemented average rate is 8.8%.

The major source of tax revenue in China is Value Added Tax (VAT), and in 2001 it made up 40% of the total. The VAT standard rate in China is 17%. However, it should be noted because Chinas VAT is a VAT with a production base, tax paid for fixed assets is nondeductible. The rate of 17% in China is equal to 23% in other countries where VAT with a consumption base is applied and tax paid for fixed-assets is deductible. As a matter of fact, in most countries VAT are less than 20%. For example, the US does not levy VAT, and its rate is zero; the VAT rate in Singapore is 3%; the VAT rate in Japan is 5%; the VAT rate in Canada and Thailand is 7%; the VAT rate in Australia, Korea, Philippines, Indonesia and Mexico 10%. It can be seen from Table I that Chinas VAT rate is one of the highest. Indeed, in the world there are only eight countries with a VAT rate more than 22%, and China is one of them.

Wang, D., Tax Burdens in China.


Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

Table I. VAT Standard Rates Higher Than 20% Country Hungry Denmark Sweden Slovak Iceland Uruguay Czech Republic China Norway Poland Source: Chen Zhimei (2000) Rate % 25 25 25 25 24.5% 24% 23% 23% 22% 22%

Corporate income tax in China is charged at the rate of 33%. However, the allowable deductions for corporate tax are too limited. For example, only 800 yuan is deductible as wage for each employee every month. If an employees monthly salary is 2000 yuan, only 800 is exempted from tax, and his or her employer has to pay tax for the remaining, 1200 yuan. Even worse, the employee has to pay personal income tax for the total 2000 yuan. In this regard there is a double taxation.

Wang, D., Tax Burdens in China.


Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

Table II. Personal Income Tax Rates Schedule 1 2 3 4 5 6 7 8 9 Monthly taxable income (wages and salary) Income of 500 or less That part of income in excess of 500 to 2000 That part of income in excess of 2000 to 5000 That part of income in excess of 5000 to 20000 That part of income in excess of 20000 to 40000 That part of income in excess of 40000 to 60000 That part of income in excess of 60000 to 80000 That part of income in excess of 80000 to 100000 That part of income in excess of 100000

RMB yuan Rate% 5 10 15 20 25 30 35 40 45

It is interesting to note that personal tax is calculated on monthly income. Because income fluctuates widely each month, it is easy for taxpayers to go up to higher tax grades. The limited exemptions create another problem. Taxable income is monthly income after lump-sum deduction of 800 yuan and certain items (at present including only basic pension insurance premium, medical insurance premium, unemployment insurance premium and reserve funds for housing) are ruled as expenses, and other deductions are forbidden. Personal income tax applies the nine-grade progressive rates as shown in Table II above.

Personal income tax is progressive, but it is not the major source of tax revenue, since it constituted only 6% of the total revenue in 2002. The other taxes in China are not progressive. Therefore we have reason to believe that in China taxes are proportional taxes, not progressive taxes.

Wang, D., Tax Burdens in China.


Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

Table III. Elasticity of tax and Tax-GDP Ratio (Calculated at current prices) Year Growth rate of GDP% Growth rate of tax% Elasticity of tax Tax-GDP ratio% 1995 25.1 17.8 0.71 10.3 1996 16.1 14.4 0.89 10.2 1997 9.7 19.2 1.98 11.1 1998 5.2 12.5 2.40 11.8 1999 4.6 15.3 3.33 13.0 2000 8.9 17.7 1.99 14.1

Sources: Statistical Yearbook 2002; An Tifu (2002)

Theoretically speaking, most taxes are proportional, so in normal circumstances, the growth in tax revenues should be lower than GDP growth, that is, the elasticity of tax is less than one. On the contrary, since 1997, tax growth has surpassed GDP growth, and its elasticity has been greater than one, and in 1999 as high as 3.33. It is interesting to note that in a proportional tax structure, tax revenue is progressive. This indicates that the tax growth is abnormal. The fact that tax burden and elasticity of tax are rising when GDP growth is slowing indicates that the recent tax policy in China is a policy of tax increase. For example, Ni Hongri suggests that the rapid growth of tax revenue over recent years is a result of a policy of tax increase (2002).

III. Driving Forces for Tax Growth The current tax bases and statutory rates in China are decided on the efficiency of tax collection in the early-1990s. During that time, the effective rates were low, because there were many exemptions and concessions in tax policy. In order to maintain the levels of tax revenues at that time, it is understandable that China deliberately set wider tax bases and higher tax rates. Since then, the efficiency of tax collection has been dramatically enhanced thanks to the development of computer technology and the Internet, and the enforcement efforts by tax authorities and tax collectors at all levels. In 1998, tax authorities made more efforts to collect taxes. Some taxpayers with more

Wang, D., Tax Burdens in China.


Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

than certain amount of taxable income (5 million yuan for VAT or consumption tax, 1 million yuan for business tax, and 0.1 million yuan for personal income tax) began to be targeted by the tax office. In 2001 Golden Tax Project was established and put into operation to ensure stringent administration. In 2002, a system of invoice rewards was employed to involve more citizens in the supervision of taxpayers.

Jin Renqing (2002) analyzes three elements which are attributable to the rapid growth in tax revenues since 1998. The first element is the economic development: tax growth is synchronized with GDP growth. With the proactive fiscal policy, stable monetary policy and industrial restructuring policy being implemented, China enjoyed a sustained economic development. The sustained growth and improvement of business efficiency generated a rich tax source. From 1998 to 2001, 55.2% of the increase in tax revenues was a result of economic development.

The second element is the change in tax policies, especially in the exemptions and concessions policy: the expiration (because they are due) of preferential regimes such as tax rebate for the excessive part of the tax burden to Chinese-foreign equity joint ventures, Chinese-foreign contractual joint ventures, foreign-capital enterprises, and enterprises affiliated with schools; and the resumption of a levy of income tax on the interest of savings deposits. The increase in this regard accounts for 19.2% of the total increase.

The third element is the enforcement effort. Excluding revenue from the first and second elements, the remainder is because the tax authorities made more efforts to collect tax, and this contributes 25.6% to the growth. Indeed, the strengthening of tax administration at different levels promoted the increase in tax revenue. The significant policies made by the central government were carried out to the letter by tax authorities at different levels. The principle of strengthening administration, blocking loopholes, penalizing corruption and rectifying arrears was strictly upheld. The

Wang, D., Tax Burdens in China.


Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

guiding thought of administering tax in accordance with law and managing administrators teams in line with regulations was scrupulously observed. The observance of fiscal disciplines and the rectification of tax rules were strengthened. The supervision of law enforcement and administrative power was enhanced. All these factors gave rise to a marked improvement in the quality and efficiency of tax collection, which generated approximately a quarter of revenue increase. (see Table IV)

Table IV. Contributors to Tax Growth Year Tax revenue Incremental over previous year 1998 9 09 1 00 1999 10 31 1 22 2000 12 66 2 35 2001 15 17 2 51 Total 47 24 7 08 Source: Jin Renqing (2002) Contribution from development 32 82 1 55 1 23 3 91 31.6 66.1 66.1 49.0 55.2 %

RMB billion yuan from taxation policy 24 0 50 63 1 36 23.5 0 21.1 25.1 19.2 % from enforcement effort 45 41 30 65 1 81 44.9 33.8 12.8 25.9 25.6 %

In addition to the aforementioned, departments of industry and commerce, the customs, foreign trade and economics, public security and the courts have cooperated with tax authorities in mobilizing financial resources and contributed to the successful rectification of tax arrears, a crackdown on tax evasion, fraud, and the refusal to pay tax and the maintenance of tax administration order.

The Research Center of Public Policy at Shanghai University of Finance and Economics analyzes factors contributing to the rapid growth in tax revenues and suggests that the most important element is enforcement and management (2003). Gao Peiyong believes that tax collection is enhanced by at least ten percentage points (2002). Indeed, given the efficiency of current method of tax collection, tax

Wang, D., Tax Burdens in China.


Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

rates set ten years ago are higher than they now should be.


Tax, GDP and GDP Per Capita

in US dollars revenue (in Tax/GD 2912 1312 708 529 591 152 451 246 106 197 119 55 123 151 86 118 64 29 7 P 0.296 0.271 0.378 0.374 0.457 0.141 0.42 0.358 0.185 0.352 0.261 0.12 0.315 0.414 0.357 0.52 0.394 0.178 0.11 Per-capita GDP $34100 $35620 $25120 $24430 $24090 $840 $20160 $21130 $5070 $15080 $8910 $450 $20240 $24970 $38140 $27140 $32280 $25920 $440 GDP (in billion) Tax billion)

Table V. GDP and tax/GDP Ratio

United States Japan Germany United Kingdom France China Italy Canada Mexico Spain Korea India Australia Netherlands Switzerland Sweden Demark

9837 4842 1873 1415 1294 1080 1074 688 575 559 457 457 390 365 240 227 162

Hong Kong 163 Pakistan 61 Source: International Statistics Yearbook (2002)

It can be seen from Table V that Chinas GDP ranks 6 th in the world, and that Chinas tax revenue maintains a similar position, ranked 9th in the world.

Tax is paid by people, so when analyzing the tax burden, we should take population into account.

Tax revenue/ GDP= Tax revenue/ Population/Population/GDP=Tax revenue per capita/GDP per capita

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Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

Superficially, tax revenue per capita is in inverse proportion to GDP per capita. But closer scrutiny reveals that tax burden cannot surpass the stages of economic development. Nations with a higher tax burden are those with higher GDP per capita, such as the US, Japan and Sweden. When analyzing the effect of economic development on the tax structure of developing countries, Chelliah (1989) states that, since the process of development would give rise to new potential tax bases and also generates the capacity and conditions for collecting the more difficult forms of taxation, the evolution of the tax structure would be influenced strongly, even if not governed, by the changes in the economy.

It should be noted that tax revenue is positively related to economic development. A number of researchers (e.g., Bahl [1971] and Chelliah [1975 & 1989] suggest that the higher the income, the degree of openness, the level and degree of industrialization and the level of urbanization, the higher the overall tax ratio would be. As far as a country is concerned, if it enjoys a high level of economic development and GDP, its tax base is large, and it is easy for the government to collect more revenue. Therefore, tax burdens in developed countries are higher than those in developing countries. According to some statistics, Tax/GDP ratios in advanced countries are above 30%, while those in less advanced countries are more often than not below 20%.

Table VI. Per-capita GDP and Finance Revenue/GDP Per-capita (US$) Hong Kong Taiwan Korea Malaysia Thailand Philippines China Indonesia India 25920 14087 8910 3380 2000 1040 840 570 450 GDP GDP Finance revenue

2000 Finance 0.175 0.19 0.26 0.182 0.152 0.153 0.153 0.16 0.132

(US$ billion) (US$ billion) revenue/GDP 163 28.5 309 58.7 457 118.8 90 16.4 122 18.5 75 11.5 1080 165.2 153 24.5 457 60.3

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Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

Pakistan 440 61 10.4 0.17 Lao 290 2 0.2 0.124 Cambodia 260 3 0.3 0.102 Nepal 240 5 1 0.113 Sources: Asian Development Bank (2002); International Statistics Yearbook (2002)

Although China is a country with a lower middle income, its finance revenue is the largest in the developing world. In 2000, its finance revenue/GDP ratio was 15%, and in 2002 it rose to 18.2%, maintaining a higher position in developing countries.

V. Tax and Economies of Scale

In the 1970s and 1980s, some OECD and IMF economists conducted a regression of tax burdens and jumped to the conclusion that there is no significant correlation between tax ratio and per-capita GDP. After careful study, however, it can be found that this conclusion is a rash one. In fact, the countries that do not correlate to the norm are the US, Japan and Sweden. The US and Japan are the most developed nations with large populations in the world, and their tax/GDP ratios are very low by the average OECD standard; on the other hand, Sweden with a small population has the highest tax-GDP ratio in the world, and not surprisingly, it maintains a very high tax burden.

Like the management of enterprises, when managing the economy, a country also faces an issue of economies of scale. Indeed, the major part of the national machinery consists of fixed costs, for example, a central government, a defense system, a police system, a legal system, and so on. If a country has a large population, more people can share the fixed costs, and the average cost will be reduced; in other words, there are more people to contribute to the tax revenue. It comes as no surprise that its tax/GDP ratio is small. Large nations usually enjoy a low tax/GDP ratio. In the United States, for example, it is beyond debate that its quantity of tax revenue is number one in the

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Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

world, but its tax/GDP ratio is the lowest among OECD countries because of its large population. On the other hand, nations with the highest tax/GDP ratio are more often than not medium- or small-sized, because fewer people share the tax burden.

Chinas tax revenue ranks the first among developing countries and its tax/GDP ratio is relatively high, even approaching that of some developed countries. As you know, however, its population is also the number one in the world. If the economies of national scale is taken into account, Chinas tax/GDP ratio should be at a low level.

VI. Tax and Public Goods

Tax revenue/ population is per-capita tax revenue, and its corresponding concept is per-capita public goods, because tax is the cost for the government to provide public goods. As far as private goods are concerned, its aggregate demand curve is calculated by horizontal summation, that is, the market demand at any given price involves summing the horizontal distance between each of the private demand curves and the vertical axis at that price. However, public goods are different, and the willingness to pay by the public is reflected by its aggregate demand curve which is generated by vertical summation of the individual demand curves. If the quantity of public goods characterized by nonrivalness and nonexcludability is fixed, the more the population, the less the cost to produce the per-capita public goods. It is due to the economies of national scale that more people can share the fixed amount of public goods.

The quantity and quality of public goods provided by Chinese governments are far less than those provided in advanced countries. For a long time, there is a two-tier system which separates China into urban and rural areas, and as a result 0.8 billion farmers are excluded from some - if not most - public goods enjoyed by their urban counterparts. For example, rural infrastructure is funded by farmers themselves, and governments only subsidize some of it; in some areas farmers financially support their

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Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

children for the 9-year compulsory education; farmers cannot access unemployment benefits; farmers are not covered by Medicare.

As far as people in urban areas are concerned, the quantity of public goods is decreasing though the tax revenue is increasing by more than 20% annually. For example, the coverage of Medicare is narrowing, and more and more people have to pay their medical insurance premium; governments stopped providing housing; tuition fees paid by students are increasing; in some areas, corporations have to provide education for the children of their employees.

According to the Niskanen (1971), a bureaucrats objective is to maximize his or her budget. However, a fundamental problem is that in so doing it may be inefficient. Indeed, many governments pursue economic development strategies aimed at promoting growth. Unfortunately, many studies find that government spending is an en ineffective approach to economic growth. Some quantitative studies sport this pint of view. For example, Feldstein (1997) concludes that the deadweight burden caused by incremental taxation may exceed one dollar of revenue raised, making the cost of incremental government spending more than two dollars for each dollar of government spending. Cashins (1995) study shows that each one percent increase in taxes as a percent of total output lowers output per worker by about two percent. He observes positive effects of spending from taxes, but typically the positive spending effects are only about one-half as large as the negative tax effect, which is about the same thing as saying that private sector spending is twice as productive as public sector outlays. According Ma Shuanyous (2001) calculation, in China 1 yuan increase in tax revenue will decrease GDP by 2.20-2.55 yuan.

In developed countries, governments collect tax revenues and return them mainly by providing the public with public goods. However, the Chinese government returns them by two means: public goods and public investment goods. Unfortunately, the

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Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

public investment in China is inefficient because of government failure, and the loss from the investment is at the expense of taxpayers. It is possible that the increase in public investment reduces private investment, that is, there is a crowding-out. In fact, what the government can do is to remedy the market defects; it cannot replace the market mechanism. According to a report in Chinas Economic Times on March 25, 2003, Lou Jiwei, a Deputy Treasurer, states that the central government should not, and cannot, increase investment in less advanced areas by the use of deficits for a long term to maintain their growth. Indeed, too much public investment has come to an end. Apart from its by-products, public investment leads to an over-reliance on the planning mechanism at the expense of the market mechanism. If the government invests too much and the short-termed policy of government investment becomes long-term, the market mechanism cannot function well, and this is contradictory to the objective of establishing a market economy. Because of heavy tax burdens, enterprises as main investors and participants in markets lack the motivation and capability to invest and to innovate. Thus it is difficult to stimulate private investment and consumption.

Even worse, the public investment is inefficient and huge quantities of funds were wasted as a result. By the end of 2001, Chinese governments invested 8600 projects funded by Treasury bonds with the value of 2600 billion yuan. In 2002, another 150 billion yuan were issued. According to Wu Zhongnans calculation, in the process of construction funded by treasury bonds, a project changes hands several times between contractors, and sometimes 60% of the funds have been wasted until the project reaches the builder (2003). Indeed, governments are not good at picking economic winners and losers and sometimes they waste taxpayer money on risky economic development schemes. Guo Wenxuan et al. suggest that the efficiency of government investment is lower than private investment, and that only 30% of the projects are efficient, that is to say, 70% are unprofitable (2003).

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Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

The Chinese government declares that the fiscal policy in China is proactive. As a matter of fact, the proactive fiscal policy is one-sided, because only the spending policy is proactive, and the tax policy is not. To make the fiscal policy more proactive and aimed at stimulating the economy, the policy should be a proactive policy of two-sided, that is to say, the tax burdens should be reduced.

Tax is the main source for government revenues and its basic objective is to meet the demand for public expenditures. Provided that the functions of government are decided, the levels of tax burdens should be determined by financial needs which can enable the government to function and provide public goods. However, the problems in China are that governmental departments and agencies are too large, and the employees of governments funded by the Treasury are too numerous. According to statistics, the ratios of government officials paid by the Treasury over ordinary people in the Chinese history are as follows.

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Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

VII. The Ratio of Officials/ the Population Time Han Dynasty Tang Dynasty The period of Kangxi The early 1950s 1978 Now Source: Dong Shaoguang (2003) The ratio of officials/ the population 1: 945 1:500 1:91 1:91 1:50 1:28

It can be seen from the Table VII that there is one government official out of 28 persons. Indeed, there are too many officials in China. Currently, from the center to provinces, to cities and to counties, there are five bureaucrat systems: the Party Committee, the Party Discipline Committee, government, Parliament, and the Peoples Political Consultative Conference.

An enterprise should reduce costs as a way to enhance productivity; similarly, governments as a special sector (public sector) should also enhance efficiency and reduce the costs of the supply of public goods, that is, to decrease the tax burdens of individuals and enterprises.

VII. Three Indicators to Describe Tax Burdens

For the purposes of public finance comparison, economists usually use tax/GDP ratio to describe a countrys tax burden. Tax/GDP ratio is computed by taking the total tax payment for a particular year as a fraction or percentage of the gross domestic product (GDP) for that year. As suggested by Messere (1997), however, although the tax/GDP ratio is the only way to compare tax revenues between countries, it cannot provide a clear indicator to describe the levels of influence on the economy by the government, nor describe the levels of transfer from private to public sectors. Especially in China, because there are several ways for governments to collect revenues, the ratio of tax/GDP alone cannot describe the tax burdens. Based on the government statistics,

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Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

An Tifu (2002) calculated three ratios:

1.Tax revenue over GDP, denoted by T0. It is computed by taking the total tax payment as a percentage of GDP for a given year. For example, the tax/GDP ratio in Table V is T0.

2. Finance revenue over GDP, denoted by T1. The finance revenue is budgetary revenue, including tax revenue (T0), and revenue generated by public assets and revenue from selling of public assets (TB). T1=T0+TB. For Example, the ratio of finance revenue/GDP in Table VI is T1.

3. Government revenue over GDP, denoted by T2. The government revenue includes not only the budgetary revenue (T1), but also extra budgetary revenue, fees, surcharges and other non-tax receipts collected by central, provincial and local governments (TG). T2=T1+TG.

According to Zhang Xuwei and Zhang Xuqiang (2000), the extra budgetary revenue and fees collected by all the governments accounted for 6% and 8% of GDP, respectively, and in some years, they are equal to T0. Among the three ratios, T2 reflects the financial burden of the overall economy. Therefore, T2 is more comprehensive than T0 and T1.

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Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

Table VIII. Three Tax Burdens in China Year 1994 1995 1996 1997 1998 1999 2000 2001 2002 GDP 46759.4 58478.1 67884.6 74462.6 78345.2 82067.4 89403.5 95933 100 000 Tax revenue 5126.9 6038.0 6909.8 8234.0 9262.8 10682.6 12581 15301 17 004 Finance revenue 5218.1 6242.2 7408.0 8651.1 9876.0 11444.1 13395 16368 18 194

in billion yuan T1% 11.2 10.7 10.9 11.6 12.6 13.9 15.0 17.1 18.2 26% T2% 16.4 16.5 19.3 21.0 22.5 24.1 25.1

Government T0 (%) revenue 7691.1 9661.2 13128.0 15645.1 17599.0 19784.9 22460.0 11.0 10.3 10.2 11.1 11.8 13.0 14.1 15.9 16.7

Sources: An Tifu (2002); Statistical Yearbook 2003

It can be seen from the Table that for the last nine years, T2 has been greater than T0 by 5-10 percentage points. In 2000, for example, T0 was 14.1%, T1 was 15%, but T2 was 25.1%. In 2002 T0 was 16.7%., T1 was 18.2% and I guess T2 was 26%. In fact this estimation is conservative, and some economists suggested that T2 was greater than 30%. As estimated by Gao Peiyong (2002), for example, the T2 in 2000 was 34.4%.

Since the last tax reform, tax/GDP ratio has maintained an upward momentum. Death and taxes may be inevitable, but a persistent rise in tax levels may not be, judging by recent evidence. Indeed, very few countries have consistently maintained a trend of rising tax ratios since 1995. As a matter of fact, since the late-1990s, many countries in the world have enacted or are considering tax cuts.

Forbes measures tax burdens by the use of indices of tax burden (the higher the index, the heavy the tax burden). Its conclusion is that China with an index of 154.5 is a heavily-taxed nation, ranking the third among 30 countries (next only to France and

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Proceedings of the 15th Annual Conference of the Association for Chinese Economics Studies Australia (ACESA)

Belgium). Although economic growth is slowing down, the tax burden in China is rising. From 1994 to 2002, T0 rose from11.0% to 16.7%; T1 rose from 11.2% to 18.2%; T2 rose from 16.4 to 26%.

VIII. Tax and Growth

There is mounting evidence that taxes have negative effects on economic growth. Higher taxes exert a negative impact on both demand and supply.

On the one hand, high taxes on goods and service push up prices and thus reduce consumption. As observed by Ladd and Bradbury (1988), high property taxes lower property values, causing significant loss of real wealth. This may leads to a reduction in consumption due to a wealth effect. Personal income taxes reduce taxpayers disposal income and decrease personal spending. All these will reduce demand for goods and service.

On the other hand, high taxes on personal income also force up labor costs, as employers have to compensate for the tax burden. It is understandable that taxes reduce job opportunities and sometimes lead to higher unemployment. Moreover, high corporate taxes reduce the profit retained by companies and thus deter business from investing. This will have an adverse effect on supply.

Because of the negative impact of taxes on economic growth, many economists suggest cutting taxes. For example, Hakkio, Rush and Schmidt (1996) conclude that lowering taxes significantly raises economic growth. High taxes discourage economic growth. Balanced budget reductions in taxes on wages and profits exert favorable effects on employment and growth.

Taxes are a price imposed on different activities. When the price is high, it discourages the activity being taxed. Therefore lower taxes on work, savings and

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investment encourage additional economic growth. It is accepted that tax cuts help the economy by improving incentives to earn more and build wealth.

One of the reasons why the authorities are reluctant to cut taxes is their worry about reduction in tax revenue. As a matter of fact, one noteworthy feature of good tax reform is that the actual reduction in tax revenue is always smaller than suggested by static revenue-estimation models because lower tax rates encourage taxpayers to work more, save more and invest more. The economy grows, national income increases and the tax base expands. As a result, tax cuts will generate a large enough increase in taxable income to offset the revenue loss associated with lower tax rates. Therefore, we have reason to believe that tax cuts can lead to a revenue feedback caused by better economic performance, especially in the long-run.

IX. Conclusion and Suggestion

There is a tax premature in China, since its tax burden is heavy. Chinas tax revenue ranks 9th in the world. As a developing country with the largest population, its tax/GDP ratio is high. If non-tax revenue is taken into account, its ratio of government revenue over GDP is very high in the context of the rest of the world.

International experiences confirm the basic proposition that higher taxes have adverse effects on economic growth. If tax burden in China is too heavy, it would be a good idea for the Chinese government to cut tax with the purpose of promoting economic growth. As a matter of fact, there is room for China to cut its taxes in agriculture, industry and services as well as in corporate and personal income.

Agriculture in most countries is free of tax, so the agriculture tax in China should be abolished. The VAT with a production base should be changed into a VAT with a consumption base, that is, the VAT paid for the purchase of fixed-assets should be deductible for the next stage in the areas of production or circulation. The basic rate of

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VAT should also be reduced.

As far as the corporate tax is concerned, its rate should be reduced in order to relieve enterprises from heavy tax burdens and encourage them to invest. There are some proposals to do so, for example, a reduction of eight percentage points from 33% to 25% seems reasonable.

There are very few countries in the world where monthly income is used as a tax base, therefore, personal income tax should be applied to yearly income instead of monthly income. The exemption of 800 yuan was set in 1980, when 800 yuan was regarded as high income. Now the average income is more than 1200 yuan, so the exemption should be raised.

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