The individual income tax that acts in a way defeating its purpose

Facing the increasing wide income gaps, most people expect to ease gaps by individual income tax reforms. But how to carry out the reform and what are the effects? The project of the individual income tax reform established by SIFL Institute and undertaken by Zhong Ruiqing, associate professor of the Law School of Zhejiang University, has provided a sort of thinking for the above problem.

Current Situation of China’s Individual Income Tax

The research report of Zhong Ruiqing’s team pointed out that under the constraint of the current system, China’s individual income tax has actually become the tax of the middle class. It has become a tool and a social mechanism for enlarging social unfairness. Prof. Zhong stated that China’s individual income tax is helpless for adjusting the income gaps and easing regional income gaps.

Why? Firstly, the large scale of grey income is totally free from the tax payment scope of the individual income tax, and as long as the discretion space of power exists, the power owner will have the rent that is generated due to power. The bigger share of power rent in total income, the more obvious is the role of retroegulation of the individual income tax.

Secondly, even if the income gaps are generated by legal deals, China’s current regulations on the individual income tax cannot narrow the income gaps. Under China’s tax-sharing system and GDP assessment mechanism, China’s income tax system is more favorable for capital income. Because laborers with high income own numerous mechanisms of turning labor income into capital income, the tax bearing is more likely to transfer from laborers with high income to low-and-middle income laborers, and the actual operation of the individual income tax withholding has caused wage earners with wages as their main income sources to be firmly brought into the scope of tax collection and management.

Besides, under the extreme individual income tax classification collection pattern, the improvement on collection efficiency and the reduction of collection costs have become the target, plus the detailed regulations on unreasonable tax base, tax rate, taxpaying bodies and the period of paying taxes etc., Zhong Ruiqing’s research group pointed out the feature that the effective rate of tax for China’s individual income tax presents regressive nature, making no contribution to fairness and wealth redistribution.

How Reforms Should Be Carried Out?

Though the roles that the individual income tax plays in practice is disappointing, reviewing the evolution of the policy goals that China began to collect the individual income tax, from “maintaining the national tax revenue rights and interests” to “adjusting personal income gaps” and then to “reducing regional development gaps,” the specific policies have all been perfected in accordance with the actual economic changes. In order to achieve the due policy goals for the individual income tax, how should reforms be carried out for the individual income tax in the future?

In China, once the individual income tax is mentioned, two kinds of reform suggestions appear naturally. The first is to raise the tax allowance, and the second is the transformation from collection by classification to comprehensive collection.

According to Zhong Ruiqing’s research, raising tax allowance can only partly solve the tax bearing of wages, and it can not involve the problem of non-wage income, such as income from personal services, writing fees etc. Therefore, the sharp rise on tax allowance makes no contribution to realizing more fairness. The true meaning of it lies in reducing the population of paying taxes for the individual income tax, making the individual income taxes only have more and more symbolic meaning.

Also, the latter reform suggestion cannot solve the above problems. Because the comprehensive collection can not bring grey income into its tax collection scope, thus it can not solve the most fundamental problem that influences income gaps. Of course, it seems that the comprehensive collection may lead the tax bearing of the income to being fairer, but it also can not eliminate the influences brought by competition among regions. In another word, under the drive of tax competition among regions, the regressive nature of tax rates will exist as always; at the same time, the reforms that turn collection by classification to comprehensive collection unavoidably sacrifice the collection efficiency, and this is just the basic reason why the reforms of comprehensive collection can not gain promotion in a long term.

Furthermore, because individuals are basically excluded from policy making, essential changes are hard to take place for the current unreasonable system of the individual income tax in a short term.

Actually, under the bureaucracy, the collection on direct tax unavoidably faces the dilemma of tax rate regression. Therefore under such a collection pattern, the phenomenon of robbing the poor to assist the rich will surely appear. In consideration of that economic development is still the most important task in current China, therefore tax policies still needs to take growth as its primary target. Consequently Zhong Ruiqing’s research team suggested that temporary abolishment of the individual income tax can also be one of the options.