China is proposing tax reform to ease the financial burden of lower-income earners and boosting consumption, but consumers and market watchers alike are hoping it's just a first step in helping people cope with the twin costs of inflation and runaway housing costs.
The State Council, China's Cabinet, has proposed to raise the minimum income threshold of the personal income tax and adjust tax rates and brackets so that those who earn the least will pay less or nothing at all.
There's no official timetable on the implementation of the new threshold. The proposal is expected to be reviewed by the Standing Committee of the National People's Congress in April and implemented in the second half of this year, according to an Economic Observer report.
Though no details of the proposal have been announced, the minimum income tax threshold is expected to be raised to 3,000 yuan (US$455) from 2,000 yuan. The current level is deemed too low as the majority of bottom-level wage earners are covered by it.
"There have been talks of a higher exemption for years," said Freeman Bu, an Ernst & Young partner. "China's shift of focus from pursuing absolute economic growth to improving people's living conditions in the 12th Five-Year Plan (2011-2015) consolidates the tax reform."
For the Five-Year plan that began this year, China lowered its growth target and signaled that reducing the tax burden is one way to make daily life easier for millions of people.
China now levies its personal income tax on employment income in a progressive tax system in nine brackets, ranging from 5 percent to 45 percent, depending on income.
That means a junior technician earning 2,800 yuan a month would pay a 5 percent tax rate, while a professional like a lawyer, earning 120,000 yuan a month, would pay at the highest bracket. The emerging middle-class, which earns on average between 10,000 yuan and 20,000 yuan a month, faces a 25 percent rate.
China defines income, for tax purposes, to include bonuses, lottery winnings and other income besides salary.
The proposed tax reforms may pare the current nine income brackets to possibly five or six. The 45 percent top rate is expected to stay unchanged, analysts said.
China has tinkered with its tax system in the past as incomes rise. The individual income tax threshold was raised from 800 yuan to 1,600 yuan in 2006, and further notched up to 2,000 yuan in 2008.
The 800 yuan minimum was set up in 1980, when earning this amount a month was only a dream for most people.
Living standards have been rising with economic growth. Thirty years ago, owning a color television was considered a luxury. Today fancy cars, exotic holidays, Gucci handbags and Tiffany jewelry have become the hallmarks of a higher standard of living.
"In the past 30 years, China's reform has made tremendous progress," said Joyce Xu, a Deloitte tax partner. "China is now the world's second-biggest economy. It is the appropriate time to consider improving the existing individual income tax system to better distribute wealth."
China is now trying to rebalance its economy and shift emphasis from exports to domestic consumption as a principal driver of economic growth.
Ernst & Young's Bu said a tax cut would help lower-income families by putting more money in their pockets at a time when rising prices are eroding disposable income.
China's consumer price index, the main gauge of inflation, rose 4.9 percent in February from a year earlier, stabilizing at the January rate. The data are more alarming when one looks at food prices. They soared 11 percent last month. Food accounts for an estimated 30 percent of the average household budget in China.
Guo Yue, a 26-year old white-collar worker who earns 4,700 yuan a month, said she would spend more on clothing or entertainment if she got a tax break.
"I don't need to worry about housing because my parents have bought me an apartment," she said.
Sun Xiaobu, another white-collar worker in Shanghai, shrugged off the prospects of any tax break that might save her several hundred yuan.
"Of course it's better than nothing," the 29-year-old marketing manager said. "But it won't affect my life deeply."
Sun, who is single and earns 13,000 yuan a month before taxes, lives with her mother. She is among the emerging middle class in China - the generation that received higher education and benefited from China's economic boom. But it's a generation with growing pains.
"I am still hoping, after a decade of hard work, that I can buy a decent home someday in Shanghai," Sun said. "The extra money I could save with a tax break would definitely help me put a foot higher on the ladder, but I still have a long way to go."
January's new home prices rose annually in 68 out of the 70 major cities monitored across the country, with 10 of them reporting a hike of more than 10 percent, the National Bureau of Statistics said.
There are no data available on the national average home prices. In Shanghai, new home prices dropped 10 percent in January to 20,625 yuan per square meter as the government tightened screws on home buying.
China's housing bubble, fueled by speculators, has been a stubborn problem. The government has imposed higher down payments, limits on the number of homes a person can buy, higher interest rates and even a pilot property tax trial.
While housing prices are showing some signs of starting to ease off, buying an apartment still remains unaffordable to many young couples.
But for now, the focus is on taxes as a means of creating a fairer society.
"China is a vast country with uneven regional development and hence regional variations," Xu said. "As such, there is no 'one size fits all' solution. In big cities like Shanghai, the 3,000 yuan threshold may not be enough, given the increasing cost of living."
Dong Mingzhu, a National People's Congress deputy, said during the parliament's annual session that a minimum income threshold of 5,000 yuan is needed to ease the financial pressures on the generation born in the 1980s - China's first one-child generation. Dong, vice chairman and president of Gree Electric Appliances Inc, said her view is shared by other lawmakers.
There is indeed no shortage of ideas.
Guo Guangchang, another NPC deputy, called for a tax deduction on rents to help city dwellers who can't afford to buy homes and are faced with rising cost of leasing.
Everyone is kept guessing at this stage.
"I think a 3,000 yuan threshold is odds-on," said Bu. "A higher exemption may be too much for the government to digest, factoring in the need for economic development in vast, less developed areas of China."
The new threshold may not make everyone happy.
Deloitte's Xu said the increase in the amount a person has to earn before paying income tax should not be the only device in the toolbox that is used to reduce the tax burden.
"There are a number of other options that ought to be considered, including broadening the range of exemptions, tax relief and deductions, or a system to take into account an individual taxpayer's overall financial obligations," she said.
In the United States, for example, a person receives an exemption for every child and householders can deduct interest payments on their mortgages. In Australia, there are deductions for expenses like day care costs.
Of course, the smart money may use loopholes and exemptions to put themselves into lower tax brackets, so a sophisticated and mature tax infrastructure system is needed.
China's tax system is still at an evolutionary stage, which means it may take time before a mature system is established.
There is no reason to expect a more sophisticated system overnight.
With the wealth being accumulated at an unprecedented pace in China, the source of wealth becomes more diversified. The increase in the income tax threshold relates to employment income, but doesn't necessarily address other types of income, such as income from business interests, rentals and gains from the transfer of assets.
Tax reforms addressing these other avenues of wealth should follow in the future, market watchers said.
Changes to a tax system invariably have an impact on government revenue, which is why political leaders weigh those decisions carefully.
"An adjustment in the income tax would have a limited impact on China's fiscal income," said Xie Dongming, an OCBC Bank economist. "It's bearable for a growing economy like China."
Rapid economic growth, rising prices, a recovery in exports and stricter tax collections boosted China's tax revenue last year 23 percent to 7.3 trillion yuan from 2009.
Last year, revenue from personal income tax grew 22.5 percent to 483.7 billion yuan, accounting for about 5.8 percent of government income.
China's 2011 draft budget projects a 7.5 percent increase in individual income tax collections, presumably incorporating the effects of any proposed tax reform.
