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China is considering capital gains charges that will increase taxes for the wealthy and help narrow the fiscal deficit but a sustainable increase in tax revenue requires deeper reform, say advisors some of whom are calling instead for a cut to the maximum personal tax rate to close a loophole.
Currently, many high-income earners choose to receive their incomes from companies that they set up to take advantage of the much lower corporate tax rates.
While changing the rules could limit the practice, there is concern about the impact on small business owners who don't contribute much to tax revenue but who form the bedrock of the economy and provide the most jobs.
Companies are now taxed at a maximum rate of 25% with smaller firms whose annual revenue is under CNY3 million paying the discounted rate of 20%. Meanwhile, the maximum individual income tax rate stands at 45%.
"It is better to lower the maximum personal income tax rate to match the corporate rate of 25% as such a move will increase the contribution of direct tax to revenues as well as boost consumption in line with the dual circulation strategy," said Zhang Jianping, director of the Center for Regional Economic Cooperation of Ministry of Commerce.
The latest five-year plan includes tax reform but given President Xi Jinping's calls for more equitable wealth distribution and the need to maintain spending while trimming the fiscal deficit, the government is unlikely to attempt any tax cuts soon, advisors said. So far this year, the Ministry of Finance has pledged to retain temporary post-pandemic tax and fee cuts for firms, further limiting the possibility of any reduction in personal income taxes.
"For the next step, the government is planning to increase taxes on high-income earners, for example, through charges on entrepreneurs' and bankers' earnings from stock and other investments," said Zhang Yiqun, director of a fiscal studies institute affiliated with Jilin province's finance department. However, such a move is unlikely to benefit the lower income group unless the extra revenue subsidizes social security programs, including building houses, he added. Capital gains rules now cover most royalties but gains from stocks and property are almost entirely exempted from tax.
Personal income tax currently accounts for about 6.3% of China's total tax revenue whereas the average of OECD countries is more than 20%, a level that policy advisors think China should aim for as it moves toward developed country status.
In a speech in August, Huang Qifan, a prominent policy advisor and former government official, said that lowering personal tax rates could also persuade people in tax havens such as Hong Kong and Singapore to return to the mainland where their businesses are located. In that case, the tax revenue from personal income tax may go up as the base increases.
A cut to personal income tax rates will limit evasion and save the money the government now spends on tax subsidies to attract talent with much needed skills, said a fiscal science advisor who is not authorized to speak with media. He said capital gains taxes could be key to balancing the deficit as the current income tax regime only identifies people with high salaries rather than people who have high incomes.
In 2020, overall revenue dropped by nearly 4% but that from personal income taxes rose more than 11% y/y, partly as wealth increased, driven by the asset boom.