Patrick Chovanec says:
Smart tax cuts can play a role in stimulating innovation and consumption in China, and hence growth. But the key is cutting the right taxes, and stimulating the right things. China's current tax system is geared towards subsidizing production (particularly exports) and investment (particularly real estate) at the expense of savers and consumers. This needs to change, but unfortunately many of the tax "reforms" officials are currently talking about go in the wrong direction. Let me give three examples:
Lower and middle-income earners account for over half of all income tax revenue in China (compared to the U.S., where the top 10% of income earners pay 71% of federal income taxes, and the bottom half pay only 3%). This places a huge burden on lower-income earners and suppresses consumption. The solution, some Chinese policymakers believe, is simple: make the tax code more progressive. They even started to shift in this direction earlier this year. The problem, though, isn't the tax rate -- China's top marginal rate is 45%.
The problem is uneven enforcement and collection. SOE employees -- including top management -- receive a lot of their compensation in-kind (free food, free housing, free car with driver, etc) and tax-free. Business owners can classify their income in ways that avoid taxes. Officials, we all know, receive much of their income under the table. The only people who actually pay 45% of their real income are foreigners or Chinese nationals working for foreign companies. Raising their tax rates -- which are already high -- will just drive people to Hong Kong.
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