China Clarifies Details for the Coming Fiscal and Tax Reforms

November 25, 2013 Posted by China Briefing Reading Time: 4 minutes

Nov. 25 – One of the key focal points mentioned in the “Decision on Major Issues Concerning Comprehensively Deepening Reforms (hereinafter referred to as the “Decision”)” is to deepen the reform of China’s fiscal and tax system. Recently passed during the Third Plenary Session of the 18th Central Committee of China’s Communist Party (Third Plenum), the Decision is considered the guideline for mapping out China’s economic policies in the coming years.

In an interview on November 20th, China’s Minister of Finance Lou Jiwei introduced the details of the fiscal and tax reforms that will be implemented after the Third Plenum. Lou explained that reforms will be achieved by fulfilling three objectives:

Improving the budget control system;
Consummating the tax system; and
Building an administration system with an appropriate allocation of fiscal and governmental responsibility.

Improving the budget control system
Minister Lou explained that the budget control method used by the government will shift from the current balanced budget to an expenditure and policy-oriented budget. This means that the amount of tax revenue collected by local governments will be based on an economic forecast from the central government, rather than the current system of economic target setting. Using this method, local governments will be incentivized to collect taxes strictly according to the law and not collect more taxes than they are supposed to. Under the new budget control system, local governments would have reduced power to set their own taxes and fees.

Another change will be the building of a budget balancing system which will extend beyond one year so that budget deficits can be made up over the following years. This requires fiscal policies to be formulated more proactively and sustainably.

Additionally, the disclosure and transparency of the budget will be enhanced so that the public will be more aware of government policies and spending.

According to Lou, the new budget control system will sever the connection between regional GDP and the expenditures of local governments, since this mandatory connection has been proven to produce rigid and inefficient government behavior.

Consummating the tax system
Reforms in the tax system will put an emphasis on the determinant function of the market in resource allocation. Lou explained that the current value-added tax (VAT) reform collects VAT in lieu of business tax, thus switching the production-oriented VAT to a consumption-oriented VAT. VAT has also been introduced into the service sector. Such an arrangement is intended to eliminate the problem of double taxation and build a tax system that better fits the nature of the country’s industrial development.

The next step in the reforms of the consumption tax system will be initiated by adjusting its scope and tax rate. The reforms will make the consumption tax more functional with respect to adjusting high energy-consumption, high pollution products and certain luxury goods.

The Decision also proposed the implementation of more direct taxes, for example, property tax. Direct tax refers to tax paid directly to the government by the persons on whom it is imposed. Currently, only Shanghai and Chongqing collect property tax based on a pilot program begun in 2011.

Another important act that could affect foreign investors is the cleansing of existing preferential tax policies. Minister Lou believes that there are currently too many different preferential tax policies exercised in different regions throughout China. This situation has had a severely negative impact on the state tax administration as well as on fair competition in the market.

Regional tax incentives that have been proven to have positive effects should be applied nationwide. From now on, all preferential tax policies will be enacted through a unified system constituted by specialized tax laws and regulations. These changes put a question mark over whether existing regional development zones will lose their competitiveness in attracting investments, since they might not be able to offer special tax treatments anymore.

Building an administration system with an appropriate allocation of fiscal and governmental responsibility
The rationale behind this principle, according to Lou, is to explicitly carve out the allocation of duties between the state and local governments. The Decision makes clear that the central government should take on more duties and related expenditures in order to reduce the burden on local offices.

The administration system has been rife with confusion. Previously, both the central and local governments were often at loggerheads as to whose responsibility certain duties were and which financial obligations to meet. It was not unusual for the central government to try and intervene in a project that a local government ostensibly had the right to pursue on its own. On the other hand, it was also common for local governments to try and overreach their areas of responsibility, especially when it came to financial issues. The reforms seek to amend these types of issues.

Minister Lou explained that, currently, many fiscal affairs that should be undertaken by the central government are delegated to the local governments. This creates a situation where spending from the central treasury accounts for only 15 percent of the total expenditure of the country, whereas the spending of the local governments constitutes 85 percent. Therefore, the local governments are under a lot of financial pressure, and at the same time, they are not motivated to accomplish tasks that do not match their assigned responsibilities.

It is hoped that by reforming the allocation of government spending there may be an alleviation of the concerns about the growing debt levels of local governments. However, Lou added that the current fiscal revenue allocation will stay the same.

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