The role of tax revenue is important to both fiscal capacity and economic growth. Tax revenue is the major source of the fiscal budget. Also, public service provision is funded by tax revenue. In 2015, tax revenue in China reached over RMB 11 trillion, with a 6.6 percent growth compared to 2014. The ratio of tax revenue in fiscal revenue and GDP is 72 percent and 16 percent respectively (Ministry of Finance, 2016).
Administrative arrangements for the tax system (i.e., tax administration) are critical in the tax system. Key administrative issues include tax evasion and avoidance as well as administrative and compliance costs (Slemrod and Yitzhak, 2002). It has been argued that "tax administration is tax policy" (Casanegra, 1990). Currently, there are about 800,000 government employees working under the State Administration of Taxation, accounting for more than one tenth of civil servants in China. However, similar to other developing countries, low capacity in tax administration is a constraint for the Chinese tax system.
First, the tax evasion rate at the firm level is high with a low capacity in tax administration. It was estimated that the tax evasion rate was around 41 percent in a recent enterprise survey (LaPorta and Shleifer, 2014). Second, tax compliance at the individual level is also low. In 2015, the individual income tax accounted for less than 8 percent in total tax revenue and it is believed that low tax compliance is one reason to explain this small share of income tax revenue. Given the current tax administration capacity, the tax authority does not have enough information of the income and expenditure levels of individuals (“How to raise”, 2015).
Third, in recent years, with more multinational corporations operating in China, international tax avoidance and evasion is becoming more significant. Considering the sophisticated techniques in international tax avoidance and evasion that are used by multinational corporations, China’s tax administration capacity is not sufficient.
Fourth and most importantly, the administration cost is relatively high in China. For example, it was estimated that tax administration costs amount to RMB 5-8 for every RMB 100 collected in China (“Tax management reform”, 2015). It is extremely high compared to other countries. For example, in Japan and the US, tax administration costs amounted to just 1.74 percent and 0.47 percent of tax revenue respectively in 2013 (OECD, 2015).
There are two major institutional reasons for this low capacity of tax administration (Qian, 2016). First, the low capacity and the high cost of tax administration stem from the decentralization of tax administration (Cui, 2015). The responsibility for tax collection is decentralized to the county and the township levels, with about 80 percent of employees in State Tax Bureau working in the county and township levels (Cui, 2015). Only 0.1 percent of employees in the State Administration of Taxation work in the headquarters (OECD, 2015). Many local staff in tax administration may not have enough professional and legal knowledge for managing tax collection. With the decentralization, there are no economics of scale since decisions are made by hundreds of thousands of local tax collectors. In many cases, there are conflicts between different laws and regulations, and local staff in the tax authority have discretion for tax collection (Nie, 2015). Also, there is likely to be more uncertainty as third party services for managing tax are underdeveloped. Tax evasion is more likely to happen and the tax administration cost is high.
The tax evasion rate at the firm level is high with a low capacity in tax administration. It was estimated that the tax evasion rate was around 41 percent in a recent enterprise survey.
Second, the other reason for the high cost is that local tax collection authorities are fragmented. Since the 1994 tax reform, both the State Tax Bureau and the Local Tax Bureau have managed tax collection. The State Tax Bureau is expected to collect shared taxes and the Local Tax Bureau is supposed to collect local taxes. However, for many taxpayers, they are subject to different types of taxes, which include both shared taxes and local taxes. These taxpayers have to claim tax for both agencies. Similarly, both agencies may audit the same taxpayer according to their own rules and standards. For example, these two agencies have different measurements for tax bases. In this case, for firms or individuals, tax compliance cost is relatively high. Tax administration costs are also higher when multiple tax authorities directly interact with taxpayers.
Several recent initiatives have been announced by the State Council to improve tax administration. First, in December 2015, a plan was announced to address the fragmented structure of tax collection between the State Tax Bureau and the Local Tax Bureau (“Plan to deepen”, 2015). According to this plan, while there will still be two tax authorities, responsibilities for both tax agencies will be further clarified and each tax will be collected by one agency. For the State Tax Bureau and the Local Tax Bureau, each will have a service outlet in the other’s service stations.
An updated information sharing system for tax management, the Golden Tax project, is going to be built up in 2016. By 2018, all data for tax administration, in particular the information of large scale enterprises, should be centralized. This plan will also address the issue of international tax avoidance and evasion. According to this plan, China will follow recommendations from the G20/OECD Base Erosion and Profit Shifting (BEPS) initiatives and a cross-border, cross-industry tax monitoring system will be set up by 2017.
Second, in March 2015, a legislative amendment was approved by the National People’s Congress which stated that by 2020, a tax can only be levied and tax rate adjusted with an endorsement in the law. This principle of “statutory taxation” (“shui shou fa ding”) is critical to reduce uncertainty in tax collection. Third, a draft version of the amendment of China's Tax Collection and Administration System was released in 2015 and the amendment is expected to be sent to the National People’s Congress by the end of 2016. In the new amendment, sanctions for tax evasion will be specified and also the rules for information sharing for addressing international tax avoidance and evasion will be revised.
With these initiatives, improvements in tax administration are expected. However, institutional constraints for the low capacity of tax administration are still there. While new information sharing platform have been planned to centralize information in the near future, the issue of centralizing the decision making process in tax collection, audit, and management is still a concern. Also, while there are several initiatives to streamline local resource allocation for tax collection, the local fragmentary structure of the tax agencies still remains.
In the future, policy makers may consider two more directions of reform to improve the tax administration capacity. One is to encourage the development of third party advisors in tax services to improve capacity and reduce the cost of tax administration. The other is that the future allocation of resources and the division of labor between the State and Local Tax Bureaus may need to take into account the reforms of the intergovernmental fiscal system.
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LaPorta, R. and Shleifer, A. (2014). Informality and development. Journal of Economic Perspectives, 28(3), 109-126.
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Nie, R. (2015). Mohu biaoshu jiang ling ‘shuishou fading’ luoxu [Vague enunciations make statutory taxation untenable]. Financial Times (Chinese). Retrieved from http://m.ftchinese.com/story/001060963
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