Tuesday, June 7, 2011

CHINA - Reforming the tax will not reduce inequalities

Two recent reports from China have attracted the attention of Western media. One is very serious and the other is less, but they both show how rising inequality has become a real political problem in this country. The first is the proposal of the Business Council of State to modify the rates of income tax to ease the burden of the working class and higher taxes for the rich.

It's really important news. The second information, reported by The New York Times, is that in some cities, the government has limited the size of graves to prevent the wealthy from erecting sumptuous monuments that irritate people. For those who know the intricacies of the Chinese tax policy, tax rates should have been changed long ago, but this is probably not the most effective way to reduce income inequality.

And for the cynical observers of local governance, limit the height of headstones at a meter is certainly a nice shot in terms of public relations, but this does not replace measures which actually treat the root causes of the increase in inequality. As in many other transition economies, income inequality in China are due to several factors.

But a relatively minor change to the income tax - the tax threshold would rise to 3,000 yuan [326 euros] per month, against 2,000 yuan today - is unlikely to make a difference. Overall, the Chinese tax system is regressive effect [plus amounts subject to tax, the greater the tax rate decreases].

The value added tax (VAT) and consumption tax (considered regressive) accounted for approximately one third of revenue last year. Taxes on wages (such as social security contributions), they also graduated, accounted for 2.5% of wage income. The share of income taxes in total tax revenue has not exceeded 5.8%.

This system is far from being a powerful tool of redistribution. In general, the collection of income tax in developing countries is costly, inefficient and difficult, mainly due to the preference for cash payments in commercial transactions, the failure of accounting practices and the importance of the informal sector.

Mainland China is no exception to the rule, so that even if the reform of the income tax was more radical and resulted in a more progressive, it was unlikely the desired effect. To reduce income inequalities, Beijing should consider additional measures. It should first raise the wages of Chinese workers.

For ten years, their growth in mainland China is lower than the gross domestic product (GDP). If one refers to the GDP by provinces, the share of wages in GDP declined from 53.3% in 1990 to 39.7% in 2007. This relative decline slows consumption growth and widening income inequality, as workers are, relatively speaking, worse off.

To increase wages, it would increase the bargaining power of workers vis-à-vis their employers, to protect the rights of workers and invest in human capital. Steps in this direction have been proposed, but no real progress has been made. Second, transform the Chinese society increasingly divided into a truly harmonious society [as official goals] would require a genuine redistribution of wealth, and not just income.

Sociological studies show that the distribution of wealth is more unequal than income. Now it is technically and economically feasible to address this problem. The Chinese state is probably the richest in the world. Its industrial heritage and its foreign exchange reserves amount to several trillions of dollars.

Redistribute some of that wealth to the population and reduce inequalities would instantly build an "ownership society". Halving the huge foreign exchange reserves could pay the equivalent of 1,000 dollars to every Chinese, which is one fourth the average annual income per capita. The fight against corruption should be the third supplementary measure.

Although it is difficult to accurately measure the effects of corruption on income inequality, studies show that in the country on a political level, people closely associated with corruption inequalities. According to a pioneering study carried out [with more than 4,000 homes] by Wang Xiaolu, deputy director of the Institute of Economic Research of the China Foundation for Reform, the amount of income concealed [fringe benefits, bribes, kickbacks , undeclared work and tax evasion] reach 9,300 billion yuan (about one third of GDP).

Also according to the survey, 10% of the richest households is 51.9% share of total income [they earned 26 times more than the poorest 10%, not 9 times, as claimed by official statistics] . While the struggle against corruption is a long-term and politically difficult. But its benefits are immediate.

Impose the prescribed manner, managers and officials to disclose their wealth - and enforce these rules - would be a step in the right direction. China's interest to slow, if not reverse the worrying trend in inequality observed over the last thirty years. In addition to creating social tensions, inequality may impede sustainable economic development.

Right now, Chinese leaders are seeking at any cost ways to avoid falling into the "trap of middle-income countries" (where the annual income per capita has risen and is between 3,000 and 10,000 dollars, the GDP tends to stagnate). However, according to studies conducted in Latin America, the inequalities are often the main cause of this trap.

The focus on inequality in China and proposed reforms to the reverse could not be better.

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