I wrote an article for China Economic Review's March issue on China's income tax reform. In the article I emphasized that the voices of middle class discontent on the Internet have led to some efforts by the government to alleviate the tax burden of the middle class and improve the transparency of how taxpayer money is spent. But I increasingly feel that maybe I have over-estimated the power of the middle class in China. More and more evidence is showing that China is a very polarized countries, with over 80% of the total wealth concentrated in the hands of the top 10%, and the middle class is actually very small since the majority of people remain in the low income class. That helps to explain why luxury brands from BMW to LV are doing well here while overall the share of consumption in GDP remains unprecedentedly low.
In my article on income tax, I left out some crucial numbers because I didn't know what to make of them at that time. According to our Ministry of Finance, when the threshold of taxable income was raised from 2500 yuan per month to 3500 yuan per month, the number of people who have to pay income tax was reduced from 84 million to 24 million. I was shocked by that number, so we only have 24 million wage earners who make over 3500 yuan (around 558 USD) a month? And 60 million people who we used to consider middle class are only making 2500-3500 yuan a month, which can barely pay for basic living needs in major cities? Of course this number does not tell us how much capital income and grey income that rich people are getting, but it is a sobering fact for those who are counting on the ever-growing demands of China's new middle class.
How much influence do the middle class have on policy makers? I am becoming less and less optimistic. As Bloomberg pointed out during this year's National People's Congress Meeting, the so-called people's national congress is made up of billionaires whose wealth"make capital hill look like pauper". Only in a system of state capitalism can you see such a marriage of capital power and political power. And you expect these billionaires to represent the voices of the middle class?
My full CER article here:
Taxation and middle-class discontent
Monday, March 12, 2012 -- 12:00 am
by Jin Ge
As Mid-Autumn Festival approaches each year, complaints begin to crop on Sina Weibo, China’s largest microblog platform, about the so-called “mooncake tax.” Since 2009, the policy has dictated that the round cakes many companies give their employees as a gift each fall should be considered a form of personal income, and are therefore subject to income tax. It is a simple policy, yet each year it invokes the ire of netizens who criticize it as “greedy” and “intrusive.”
The public outcry over taxation has been growing louder in China, largely in the forums offered by new media such as microblogs. In 2011, issues like the tax burden, government accountability and the unfair distribution of wealth were all hotly debated on the internet by China’s increasingly vocal middle class. This outpouring of emotion was different from the kind of discontent expressed by the protests of migrant workers or peasants, which usually assert a personal experience of injustice. Instead, these online discussions focus more on the structural problems of the Chinese economy.
This outburst of discontent seems to be rooted in the widespread feeling among the Chinese middle-class that their income and living standards have not grown at the same pace as the country’s spectacular GDP numbers or the government’s fiscal income. This feeling is not unfounded. The government’s fiscal income hit a new record in 2011 of RMB10.3 trillion (US$1.6 trillion) – up more than 200% over the last six years, according to the Ministry of Finance and National Bureau of Statistics. In the same period, average incomes increased only around 10% each year. In 2010, the average income for urban residents grew 7.8%, while rural incomes rose 10.9%.
The Chinese government is aware that the popular opposition to the distribution of wealth between government and society poses a threat to its legitimacy. To diffuse the tension, it is trying to control the flow of information through measures like “real-name registration” on microblogs.
But despite criticism in the Western media, it is not merely trying to stifle complaints; it is also trying to address the problem. Top leaders repeatedly stressed in 2011 that the government is determined to increase average incomes and to make domestic consumption the new growth engine of Chinese economy, rather than exports or fixed-asset investment.
The government’s efforts at income tax reform demonstrate its determination in this goal. Last April, the National People’s Congress published a draft of the new individual income tax law on its website and invited citizens to submit suggestions online. More than 200,000 netizens, including myself, took this novel chance of civic participation. To my surprise, the final version of the new law, published in July, reflected public opinions and exceeded popular expectations in many ways. For example, in the first draft the threshold for taxable wages was RMB3,000 (US$476.6) per month, but in the final version it was raised to RMB3,500.
The reforms were obviously directed at taxing lower-income earners less to help close the wealth gap. China runs a progressive tax system, meaning the tax rate increases as taxable income increases. The tax rate for the first bracket, people earning taxable income of between RMB0-1,500, was reduced from 5% to 3%. This means that a recent college graduate who makes RMB5,000 a month will now only be taxed RMB45 per month, down from RMB75 previously.
The new system is not lenient on the wealthy: The highest tax rate under the new law is 45%, though that is only applied to the portion of an individual’s monthly income that exceeds RMB 80,000. That is much higher than the highest rate in Hong Kong (17%) or Singapore (20%), which are known for using low tax rates to attract international elites. But China’s range of 5-45% is roughly in line with other big economies with progressive tax systems. For example, US federal income tax rates range from 10-35%, while Japan’s income taxes range from 5-40%, and the UK’s range from 20-50% – though these countries all have various local taxes and tax rebate policies that complicate comparisons of the tax burden.
Beyond the math
These reforms are positive, but online discussion threads point out that many major issues remain to be addressed, such as the “grey” income of officials and the heavy burden on small enterprises. The government still spends far more on its own ambitious fixed-asset investment projects than on the social programs the public demands.
In public discussions, how tax money is spent appears to be becoming an even bigger concern than tax rates. The debate was sparked in part by the tragic accident last November, in which 21 children were killed in an overloaded school bus in Gansu province; the bus had only nine seats but was carrying 64 kids. Angry netizens repeatedly asked questions such as: “Where did our tax money go? Why are children crammed into shabby buses while government officials drive fancy cars?” The incident (and complaints) prompted the government to allocate a special fund to subsidize school buses in poor areas.
Despite these efforts, it is clear that the Chinese government’s spending on social welfare is low by any standard. In 2010, for example, total government spending on Medicare was about RMB480 billion (US$76.2 billion). That figure was up 20% from 2009, but still represented only 1.2% of China’s GDP.
In comparison, federal spending on Medicare and Medicaid in the US (which is not known as a welfare state among developed countries) has exceeded 3% of GDP in recent years, according to the Congressional Budget Office. No wonder that news reports on the possibility of China giving funds to indebted European countries provoked responses from Chinese people such as: “If our government is so rich, why can’t it save us first?” “Don’t people in Greece still enjoy much better social services than we do?”
Due to the intensified information and idea sharing on the internet, the Chinese middle-class are increasingly aware of the relationship between the government’s macro-economic policies and individual living conditions. The policymaking process in China is still far from democratic, but the income tax reform example shows that the government is becoming more responsive to public demands. At the very least, there is a consensus both inside and outside the government that to make China’s economic development more sustainable and inclusive, we need a prosperous domestic market supported by the middle class.
The current system still does not seem secure or fair to many of these people. Most Chinese agree that only by raising domestic consumption can China switch to a more sustainable and inclusive model of growth, but this cannot happen without a prosperous middle class that feels secure and confident enough to spend more. Let’s hope we see more meaningful dialogues that lead to reforms to improve government accountability and empower the Chinese middle class.