China is expected to carry out a new round of fiscal and tax reform, in a bid to help promote high-quality growth and improve the well-being of the people. Three experts share their views on the issue with China Daily.

Horizontal and vertical, tax-sharing reform

The Central Economic Work Conference of 2023 emphasized the need for a new round of reform measures, including new fiscal and tax reforms.

Since the launch of reform and opening-up in the late 1970s, several significant reform measures have been initiated at the macro level, with fiscal policy being chosen as the "foundation and important pillar of national governance", and its institutional reform serving as the vanguard. The imminent implementation of the reform measures has once again placed the deepening of fiscal and tax system reform on the agenda.

A brief review of China's more than four decades of reform and opening-up shows a shift in the fiscal system toward serving the overall situation, starting from the early 1980s with the "division of revenue and expenditure, and graded contracting" ("separate kitchen for each family") system.

The most significant milestone in this transition from "administrative sharing" to "economic division" was the establishment of the "tax-sharing system" in 1994. This breakthrough reform, which essentially involved economic division, addressed not only the relationship between the central and local governments, but also that between the government and enterprises, the central and local governments, and various levels of government and taxpayers, thereby ensuring that these three major relationships were properly handled.

Following the establishment of the tax-sharing system framework, all enterprises, regardless of size, administrative level and economic nature, were treated equally when it came to tax laws. This key institutional reform established a "level playing field for fair competition" for all enterprises.

Subsequently, the administrative levels of State-owned enterprises became less important, allowing for mergers and reorganizations across different administrative levels and economic structures. This reform made possible the previously inconceivable mixed-ownership reform of SOEs and non-SOEs, as well as cross-administrative-level mergers and reorganizations.

To move toward a modern tax system, the 1994 reform provided a relatively standardized framework, consolidating the previously fragmented individual income taxes (for foreign experts), personal income taxes for affluent Chinese nationals, and income taxes for individual industrial and commercial households into a relatively standardized personal income tax system. This could be further deepened through subsequent reforms.

In summary, the proper handling of the three relationships — between the government and enterprises, between the central and local governments, and between various levels of governments and tax payers — has been institutionalized since the 1994 reform which in turn has facilitated modernization.

However, due to various constraints, the 1994 reform had to compromise on several issues. The government has taken a series of measures to deepen fiscal and tax system reform since 1994, which have improved China's economic and fiscal conditions, and to this day, the tax-sharing system framework between the central and provincial governments remains intact.

However, the tax-sharing system below the provincial level is yet to be fully implemented. It is still complex and variable, and is subject to negotiation and bargaining, including dividing revenues.

To build a high-level socialist market economic system, as required by the central government, it is imperative to explore and timely introduce a new round of comprehensive fiscal and tax system reforms.

Therefore, there is a need to fully adhere to the basic institutional achievements of the 1994 tax-sharing system reform, recognize the root causes of the financial difficulties at the grassroots level, local hidden debts, and "short-term behavior of land finance", which are not due to the tax-sharing system per se but because of the inadequate deepening of the tax-sharing system reform both "horizontally and vertically," especially below the provincial level.

The overall approach for this new round of fiscal and tax system reform should be to rationalize the functions of the governments at all levels, help their transformation and standardization, and align them with the "flattening" of government levels by streamlining institutions. The higher authorities should rationally allocate the powers and expenditure responsibilities of the central, provincial, municipal and county governments, and improve the transfer payment system.

The higher authorities should also deepen the reform of the budget management system, build a reasonable local tax system, promote tax reform for "structural adjustment and mode transformation", and strengthen and optimize comprehensive budget performance management. This approach will enable the fiscal and tax system, and fiscal allocation to play their rightful roles in helping realize the strategic goal of the rejuvenation of the Chinese nation through modernization.

Soft rebound paves way for policy transformation

As the Chinese economy moves toward a soft rebound, it may launch large-scale fiscal and tax reforms to facilitate and boost growth for years to come.

Citing a Japanese "financial journalist", US-based Newsweek recently reported that "China's economy not only expanded less than reported but also contracted in 2023". Apparently, Newsweek thought it had a scoop. Stunningly, dismissing all the growth figures of China by global development banks, the Newsweek report relied on Tamura Hideo of Sankei Shimbun that represents Japan's ultra-nationalist far-right.

It was déjà vu all over again. Last summer, when Shanghai began to rebound, Newsweek reported that it had turned into a "ghost town". Then its economic authority was a geopolitical hitman, who recently popped up again at a Texas border rally blaming the Hispanic migrants, based on conspiracy theories, for the United States' problems, according to the very same Newsweek. There is a pattern of methodical obfuscation among the leading global media outlets. Economic reporting is increasingly subject to geopolitical agendas.

However, without substantial official support to boost consumption, consumption growth would likely be moderate in 2024 given the current outlook on real estate and confidence. Hence, the impending push for a proactive fiscal policy, coupled with a new round of fiscal and tax reform, to boost consumption growth. Recently, this was coupled with the biggest-ever cut to the key mortgage rate by China's central bank, to bolster the housing market.

Despite the real estate downturn, China met its economic growth target last year. With economic growth of 5.2 percent year-on-year, fiscal revenue exceeded $2.9 trillion last year, an increase of 6.4 percent from the previous year.

In 2012, as part of the overall plan of deepening reform, China embarked on a journey to establish a modern public finance system. In the past decade, the fiscal and tax reform has been gradually moving toward a reformed system. These efforts are garnering greater momentum now, as evidenced by the key economic priorities of the Central Economic Work Conference in December.

Since January, there has been increasing global interest in China's reform efforts, in particular its rethinking of the incentives it gives its local governments to support the economy.

In the past more than four decades, China's impressive growth record has dramatically improved Chinese people's living standards and eradicated extreme poverty. But like in other industrializing countries, China's growth has been accompanied by widening imbalances. The current challenges have their origin in the 2008-09 Chinese economic stimulus package of $586 billion — whose aim was to minimize the impact of the US subprime crisis-induced global financial crisis.

The stimulus did boost growth, helping the Chinese economy to recover from 6 percent to over 10 percent by mid-2009, and drive 50 percent of global growth, thus supporting the ailing West. But the stimulus also contributed to a great surge in local government debt. In particular, investment in infrastructure and housing fostered rising debt among property developers, local governments and local government financing vehicles.

Over the medium term, the goal of the impending fiscal policy reform is to improve the risk-sharing mechanisms between the central government and the local governments, to close the fiscal gaps at the local level and reduce local governments' dependency on the sale of land-use rights, as the International Monetary Fund recently said.

The effort at fiscal consolidation is based on the reduction of off-budget investment and the execution of broad social security and tax reforms, including greater reliance on personal income tax, to foster equity.

After three years of deleveraging in the ailing property sector, the Chinese economy is moving toward a soft landing in 2024 and normalization by 2025. But China is neither Japan of the 1990s nor the US of 2008-09. Despite large-scale deleveraging in the sector, homebuyers in China are actually leveraging up, as Singaporean multinational bank, DBS Bank, has reported.

In other words, Chinese consumers do not lack purchasing power. They are able to spend, and increase their spending. But being cost-conscious, they have been cautious to do so, consuming moderately and saving excessively.

Moreover, there is a great need for broad structural reforms and adequate support to cushion the impact of the adjustment in the property sector — and to unleash the pent-up consumption capacity.

China's structural potential remains high. In the West, the middle-class's real income has stagnated for four decades. In China, there are 400 million people in the middle-income group, and their number could double to 800 million in the next decade. And urbanization will likely create huge demand in sectors such as housing, education, medical and elderly care.

By 2030 an additional 240 million rural residents in China could migrate to cities. Among other things, that will translate to great secular potential for investments to upgrade urban transportation and telecom infrastructure. That means a substantial opportunity for domestic and global financial institutions.

By contrast, in the West, trade wars and geopolitics, coupled with xenophobia and unwarranted wars, have proved to be a costly distraction from requisite structural reforms in home markets.

What the world economy needs is successful growth transformation in China — and large-scale economic reforms within rather than futile foreign interventions by the West.

Transfer payment system needs improvement

The 2023 Central Economic Work Conference proposed a new round of fiscal and tax system reform. Together with other major measures to further deepen reform, this will facilitate high-quality development and strengthen Chinese path to modernization.

The fiscal and tax reform of 1994 not only helped establish a fiscal and tax framework that basically adapted to a socialist market economy, but also promoted China's economic and social development. To be fair, the fiscal and tax system established in 1994 is still effective. But deepening of fiscal and tax system reform in the new era meets the requirements for the modernization of the national governance system and governance capability.

Now the reform, if conducted, should cover a wide range of aspects, with the two most important being the relationship among financing, the market and society; and the relationship between governments, especially the fiscal relationship between the central and local governments.

Handling the relationship between the government, the market and society requires a reasonable definition of the government's functions. Based on this, the relationship between financing, the market and society can also be defined. Under the socialist market economy system, the market plays a decisive role in resource allocation, and the government's role should ensure the fair and orderly functioning of the market.

All matters concerning government revenue and expenditure, government assets and liabilities, and the movement of government funds are fiscal matters. Hence, fiscal and tax reform requires the coordination of all fiscal resources.

The coordination of fiscal resources covers all aspects and requires breaking through various related interest patterns. The reform is a difficult process, but as long as the goal is clear and the direction correct, fiscal and tax reform will eventually be achieved.

In a vast country like China, handling the fiscal relationship between governments requires the adherence to the direction of the tax-sharing fiscal management system reform and the establishment of a tax-sharing fiscal management system with Chinese characteristics. The goal of the tax-sharing reform is to further regulate the fiscal relationship between the central and local governments.

Forming a hierarchical fiscal system under the leadership of the central government, in accordance with the principle of matching fiscal powers with expenditure responsibility, is of the utmost importance. Such a system ensures fiscal sustainability at all levels, and guarantees fiscal support for public projects undertaken by governments at all levels.

The economies of scale and scope in taxation determine that larger scale fiscal resources are concentrated with the central government. This is not a problem; on the contrary, it's a good thing for a country that needs to achieve equality in public services across regions. The central government thus has sufficient fiscal resources to provide transfer payments for financially weak regions in the central and western parts of the country, thereby promoting equality in public services.

Tax-sharing is not just about dividing taxes between the central and local governments but also about providing tax revenue for local governments in accordance with their respective functions. China has 18 types of taxes, and quite a few of them provide tax revenue for the local governments, but still those are not enough to meet the needs of local governments.

The main source of income for local governments is shared taxes — the taxes shared between the central and local governments. Value-added tax, corporate income tax and personal income tax revenues are the most significant sources of tax revenue for both the central and local governments. If China's tax system does not undergo fundamental changes, this pattern will remain unchanged. So we need to re-recognize local taxes.

Any tax that provides revenue for local governments, including shared taxes, can be considered as local taxes. Following this logic, improving the local tax system becomes feasible.

In reality, central-to-local transfer payments have promoted the "three guarantees" — guaranteeing people's basic livelihoods, wages and functioning of society — at the grassroots level. The role of transfer payments cannot be overemphasized.

But central-to-local fiscal transfer payments need to be further standardized. Without appropriate rules, transfer payments may breed laziness. This obviously needs to be prevented. Therefore, it's necessary to further improve the transfer payment system, appropriately determine the scale of transfer payments, and let transfer payments play their proper role.

General transfer payments and special transfer payments both have important roles, and neither should be favored over the other. In this regard, although special transfer payments have been criticized, they are more conducive to the implementation of central policy goals.

The task of establishing a modern fiscal and tax system with Chinese characteristics is difficult. It cannot be accomplished overnight; it requires careful planning and step-by-step progress. And this is the right time for planning a new round of fiscal and tax system reform.

Source: https://www.chinadaily.com.cn/a/202402/26/WS65dbc8f7a31082fc043b8f62_3.html