Did Xi set a New Direction for Tax Reform in China?

November 2, 2017

China Briefing

Chinese President Xi Jinping hinted at a new direction for tax reform during the 19th Party Congress, which ended last week in Beijing.

Although the statements made during Xi’s speech were broad, and had little in the way of specifics, the speech could signal a new direction of reforms for China’s tax system.


Law-based taxation

Xi stressed the importance of “law-based governance” throughout his speech, and this extends to taxation. Xi said, “We must exercise Party leadership at every point in the process and over every dimension of law-based governance, and be fully committed to promoting socialist rule of law with Chinese characteristics.”

The strengthening of “socialist rule of law with Chinese characteristics” applies to reinforcing the implementation of tax laws. This would see local tax authorities following more strictly the written law, ensuring businesses and individuals follow relevant tax laws, and giving them recourse in the event that tax laws have been wrongly enforced.

More opportunities for businesses and individuals to defend their tax benefits would likely increase the importance of enlisting qualified China tax lawyers.


More equitable taxation

In his speech, Xi altered China’s longstanding “principal contradiction” to suit China’s “new era”.

Xi said, “As socialism with Chinese characteristics has entered a new era, the principal contradiction facing Chinese society has evolved.” Xi elaborated, “What we now face is the contradiction between unbalanced and inadequate development and the people’s ever-growing needs for a better life”.

Xi has placed increasing importance on bridging income and quality of life disparities between China’s wealthy coastal regions and its less developed inland. The government could use tax redistribution – possibly through adjusting individual income tax and property taxes – and the implementation of regional tax incentives to promote the development of areas “left behind” during China’s economic development.

Tax incentives in inland China will increase their attractiveness as FDI locations for foreign investors. If their wealth also increases to levels closer to coastal areas, inland China will become a vital market for goods and services.


Tax neutral principle

Xi sent mixed messages on the development of the market economy in China, reiterating his commitment to promoting the private economy but also making clear the importance of the Party and state-owned enterprises (SOEs) in the economy. In terms of taxation, Xi emphasized the “tax neutral principle” – that levying tax should not interfere in market mechanisms in determining resource allocation.

Xi stated, “We will introduce a negative list for market access nationwide, sort through and do away with regulations and practices that impede the development of a unified market and fair competition, support the growth of private businesses, and stimulate the vitality of various market entities”.

The need for administrative approval in many sectors has historically impeded the development of tax neutrality in China. However, the implementation of the national Negative List and other business-friendly reforms – such as moving from pre-approval to record-filing for establishing new investments in many industries – has aided China’s development in this regard. Efforts such as these can be expected to continue as China grows closer to tax neutrality.


Local reforms and implementation

Xi emphasized the need for the Party to maintain a strong influence in the economy because of discrepancies between state-level policy and local on-the-ground implementation. Oftentimes, however, Chinese legislation is intentionally vague, granting leeway to regional authorities to implement according to local conditions.

Xi appears to be aiming to increase communication between state and local governments to ensure laws are enforced more consistently.

Xi said, “We will expedite the creation of a modern public finance system, and establish a fiscal relationship between the central and local governments built upon clearly defined powers and responsibilities, appropriate financial resource allocation, and greater balance between regions”. Xi continued, “We will deepen reform of the taxation system, and improve the local tax system.”

The creation of a “modern finance system” and a stronger relationship between state and local governments hinges in part on the digitization of China’s bureaucracy and tax system. Greater digitization will increase transparency and facilitate communication and information sharing.


China’s tax system going forward

China underwent a comprehensive VAT reform in 2016, and 2017 saw tax authorities continue to implement and optimize the reform. Since China is just coming off a period of substantial tax reform, another round of ambitious reforms seems unlikely for 2018.

Many of the areas relating to taxation that Xi highlighted in his speech also relate to governance and the application of laws more generally. As such, greater enforcement of tax laws will likely appear in tandem with greater enforcement of other laws, such as environmental regulations and visa regulations.

Xi did not lay out concrete details for the future of China’s tax system. Nevertheless, it appears that the tax system will follow other trends in China, such as the increased enforcement to the letter of the law.

More concrete legislative updates to China’s tax system – if any – will likely be announced at the next Two Sessions meetings in Spring 2018.

Tags: china, communist party congress, tax reform, tax system, xi jinping
Posted in Asia, Macro Economics, Macro Economics