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Chapter 4 Policy Simulations

4.1 Background Analysis of Policy Simulations

Following the continued decline in economic growth, China's fiscal revenue growth fell to 8.6 % in 2004, the lowest growth rate in 23 years. However, the fiscal revenue share of GDP did not fall[1] but showed a slight increase of 0.1 percentage points over the previous year. The generalized government revenue as a share of GDP remained high at 37.2 %.

The reasons are as follows. First, from the fiscal revenue structure, the economic slowdown affected the tax revenue growth, which fell significantly. Its proportion of fiscal revenue declined from 88.1 % in 2010 to 84.9 % in 2014. At the same time, the growth of nontax revenue increased significantly, its proportion reaching 15.1 % of fiscal revenue (see Table 4.1). Nontax revenue had become an important means for local governments to make up for declining tax revenue. Second, by structure of tax revenue, the growth of indirect taxes slowed down primarily in VAT, business taxes, consumption taxes, customs duties, and other turnover taxes. Because of the growth of income and automobile consumption and the tax base for real estate tax and other taxes related to the state-owned land expansion and their high growth, the growth of direct taxes remained high. In fact, since 2011, the growth of direct taxes has been higher than that of indirect taxes in China. In 2014, the growth rate of direct taxes was 9.7 %, which was higher than that of indirect taxes by 3 %. Affected by these, the ratio of direct to indirect taxes increased substantially, from 0.48 in 2010 to 0.59 in 2014 (Fig. 4.1).

The Decision pointed out that the gradually increasing proportion of direct taxes is important to deepen China's tax reform and improve the tax system. In the past three years, following the significantly higher growth of direct taxes compared to indirect taxes, the proportion of direct taxes increased rapidly. This seems to satisfy

Table 4.1 Changes in fiscal revenue indicators from 2010 to 2014 (in billion yuan)

Items

2010

2011

2012

2013

2014

Fiscal revenue

8310.15

10387.44

11725.35

12920.96

14035.00

Tax revenue

7321.08

8973.84

10061.43

11053.07

11915.80

Nontax revenue

989.07

1413.60

1663.92

1867.89

2119.20

Tax-to-revenue ratio (%)

88.1

86.4

85.8

85.5

84.9

Nontax-to-revenue ratio (%)

11.9

13.6

14.2

14.5

15.1

Governmental fund revenue

3678.50

4136.31

3753.49

5226.88

5409.30

State-owned capital management: revenue

55.87

76.50

149.59

171.34

190.00a

Social insurance fund: revenue

1707.07

2575.77

3141.10

3599.36

4029.20a

GDP

40151.28

47310.4

51947.01

58801.9

63646.3

Fiscal revenue-to-GDP ratio (%)

20.7

22.0

22.6

22.0

22.1

Government revenue

13751.59

17176.02

18769.54

21918.53

23663.50

Government revenue-toGDP ratio (%)

34.2

36.3

36.1

37.3

37.2

Notes: 1. The government revenue defined here mainly consists of four parts: fiscal revenue, government fund revenue, the state-owned capital operating income, and social insurance funds. 2. The data table marked with ais estimated by the authors. Among them, the state-owned capital operating income is obtained as follows: the 2014 central state-owned capital operating income plus the difference between the average state capital operating income and average central state capital income for 2011–2013. The social insurance fund income is obtained as follows: the national social security fund plus the growth rate of the difference between the social insurance fund revenue and national social security fund revenue for 2011–2013

the requirements of the Decision for the reform of the tax system. However, the rise in proportion of direct taxes due to the difference in growth rates between direct and indirect taxes is different from that due to tax adjustments.[2] The former is unstable, because once the economic situation changes, the proportion of direct taxes may subsequently reverse. The declining share of indirect taxes due to economic slowdown is not the result of declining marginal tax rate, but the result of declining tax base. It only meets the Decision's requirement in a statistical sense and is not the reform result of perfecting the tax system and adjusting the economic structure that the Decision raises. The marginal tax effect of individual production or consumption behavior has not changed.

Because the tax structure is mainly based on indirect taxes, the tax burden can easily be transferred from producers to consumers and hence consumers actually

Fig. 4.1 The 2010–2014 growth rate and ratio changes of direct and indirect taxes (Data source: CEIC, Notes: 1. Indirect taxes are of 10 types: VAT, business tax, consumption tax, customs duties, excise duty and VAT of imported products, urban maintenance and construction tax, resource tax, stamp duty, tobacco tax, and tonnage tax. Direct taxes are of nine types: property tax, corporate income tax, personal income tax, urban land use tax, land value increment tax, travel tax, deed tax, cultivated land usage tax, and vehicle purchase tax. 2. The city maintenance and construction tax for 2014 is extrapolated by its proportion of VAT, sales tax, and excise tax for 2010–2013. The resource tax, stamp duty, tobacco tax, property tax, travel tax, vehicle purchase tax, tonnage tax, and other small taxes are extrapolated by their growth rate in 2013)

bear most of the tax burden. This reduces the consumers' disposable income and thereby inhibits the growth of consumption. In addition, indirect taxes do not have vertical equity features. Therefore, by reducing the proportion of indirect taxes, increasing the proportion of direct taxes, and levying more taxes directly related to the level of personal income, taxes can help balance the income distribution between businesses and residents, narrow down the income gap between all income classes, and promote consumer spending.

Finally, compared to other countries, the current ratio of direct taxes in China is still low. The proportion of direct taxes in China is lower than that in not only the developed high-income countries but also the same-income (upper-middle income), middle-income, and lower-middle-income countries (Table 4.2). Thus, there is large room for increasing the share of direct taxes in China.

In our view, we should focus on the Decision's requirements.[3] We should also adjust the indirect marginal tax rates, lower the indirect taxes initiatively, and reduce the total tax burden of the national economy. This could lead to the following advantages:

Table 4.2 Changes of the ratio of indirect tax to direct taxes in some countries and regions from 2007 to 2012

Country

2007

2008

2009

2010

2011

2012

Australia

2.63

2.72

2.65

2.35

2.49

2.68

Brazil

1.23

1.15

1.15

1.06

1.13

1.13

India

1.11

1.12

1.43

1.24

1.24

1.10

Japan

1.74

1.49

1.17

1.23

1.29

1.36

Peru

1.04

0.96

0.89

0.89

1.05

1.11

The USA

16.57

14.71

11.96

12.65

12.86

13.01

The eurozone

0.91

0.88

0.82

0.76

0.78

0.76

OECD countries

1.12

1.06

0.90

0.81

0.88

0.85

High-income countries

1.00

1.01

0.91

0.84

0.82

0.82

Middle-income countries

0.59

0.67

0.65

0.62

0.61

0.57

Upper-middle-income countries

0.64

0.65

0.67

0.58

0.53

0.55

Lower-middle-income countries

0.49

0.57

0.59

0.54

0.57

The world average

0.63

0.68

0.65

0.63

0.63

0.62

China a

0.56

0.47

0.41

0.36

0.39

China b

0.44

0.49

0.49

0.48

0.51

0.52

Notes: 1. Except for the data of China b that is obtained from CEIC database, the remaining data are obtained from WDI 2014. 2. The specific algorithm is (taxes on income, profits and capital gains + other taxes)/(taxes on goods and services + taxes on international trade). Among them, the other taxes include taxes on wages and labor, confiscation of property, income tax, and other revenues that have not been categorized

1. The increase in proportion of direct taxes will be stable and not a temporary adjustment based on economic growth.

2. Although it could bring about short-term reduction in indirect taxes, in the long term, it is conducive to economic transformation and upgrading. By promoting business investment, it can stimulate economic growth, bring about sustainable tax revenue growth, and avoid the risk of passive adjustments that can lead to continued decline of tax revenue growth rate.

3. Under the “tax price” system designed in China, it could reduce the indirect taxes' marginal rate, bring down the price level, increase the household purchasing power, promote residual consumption, stimulate economic growth, and improve the demand structure.

  • [1] See the footnote of Table 4.1 for related estimation instructions
  • [2] Structural tax cuts over the past few years, such as “replacing business tax with VAT,” tax cuts for microand small businesses, and property tax pilot. Although the tax system was fine-tuning, overall, it did not substantially adjust the indirect tax-based tax system. The decline in indirect taxes share, especially the low growth of VAT and business tax, was mainly due to the real economy shrinking and service trade slowdown
  • [3] The Decision requires that “We should advance VAT reform and simplify rate levels, and adjust the scope and rate of the consumption tax. Energy and pollution-intensive products and some highend consumer products will be subject to a consumption tax. We should establish an individual income tax system in which taxable income is defined in both comprehensive and categorized ways. We should accelerate property-tax legislation and related reform at an appropriate time and change the current environmental-protection fee into an environment tax.”
 
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