## _wp1566

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---

### I. INTRODUCTION
- Reform context:
  - In late 2013 following the Third Plenum of the Eighteenth Communist Party, China put forward an ambitious and comprehensive reform blueprint covering financial, fiscal, external, and structural reforms to help transition to high income status.
  - Fiscal reforms are an integral part of the blueprint and are key for achieving more inclusive, green, and sustainable growth.
- Paper focus and contribution:
  - Focus: revenue reforms—tax policies to facilitate economic transition to high income status, promote fiscal sustainability, and make growth more inclusive and environmentally friendly.
  - Contribution: a menu of options for revenue reforms, illustrative budget impacts, and integration with other fiscal reforms to ensure public finance sustainability.
- High-level estimates and objectives:
  - Revenue reforms could lift revenues by 4.5–6.5 percent of GDP over the medium term.
  - Provide room to address the buildup of risks in local government finances, and increase social spending, such as education and healthcare.
- Organization:
  - Section II: background of the tax system in China and local government finance challenges.
  - Section III: key revenue reform policies and budgetary impact.
  - Section IV: menu of options and how to implement them with other reforms to ensure fiscal sustainability, including reducing off-budget infrastructure spending by local governments and increasing social spending.
  - Section V: conclusion.

### II. TAX SYSTEM IN CHINA — Key findings and characteristics
- Revenue growth and composition:
  - Growth in nominal revenues in China on average has been about 20 percent.
  - Tax revenue has accounted for about 22 percent of GDP in 2013.
  - Indirect taxes on goods and services, including the VAT and business operation tax, account for more than half of tax revenue.
  - Personal income tax (PIT) accounts for 5.1 (percent of 2013 total revenues); Corporate income tax accounts for 17.4 (percent of 2013 total revenues).
  - Nontax revenues represented 14.5 (percent of 2013 total revenues).
  - After adjusting for nontax revenue and net land sale proceeds (about 2¾ percent of GDP), the overall tax burden is similar to other Asian economies.
- Fiscal design and procyclicality:
  - Annual balanced-budget practice reinforces procyclicality; plan to introduce a multi-year budget under the new budget law effective in January to help mitigate procyclicality.
  - Central government maintains a budget stabilization fund (size noted but numeric value not provided in excerpt).
- Redistribution and inequality:
  - Gini coefficient: below 0.3 in mid-1980s, risen to near 0.5 in recent years.
  - Highest income decile earners: more than 16‒18 times those at the lowest decile.
  - Taxes and transfers have relatively limited redistributive effect.
  - Reliance on indirect taxes and regressive design of social security contributions (SSCs) lead low-income earners to pay a much higher effective tax rate.
  - Hukou-linked differences in social service access weaken fiscal redistributive impact.

### III. FISCAL STRUCTURE, LOCAL FINANCES, AND DEBT RISKS
- Fiscal structure and revenue composition (percent of 2013 total revenues unless otherwise stated):
  - China: VAT and consumption tax, 28.7; VAT and consumption tax for imports, 10.8; Business tax, 13.3; Personal income tax (PIT), 5.1; Corporate income tax, 17.4; Other tax, 10.7; Nontax revenues, 14.5.
  - Recurrent property- and land-related taxes: about 7 percent of tax revenue (or 1.5–2 percent of GDP).
  - Social security contributions share in tax and social security contributions: 20.4 (percent of 2013 total tax revenues and social security contributions).
  - VAT and business operation tax in 2013 was 8.1 percent of GDP.
  - Gross land sale revenue about 7 percent of GDP in 2013 (net land sale revenue 2½–3 percent of GDP).
- Local government finances and fiscal federalism:
  - Tax revenues: 18 percent of GDP in large cities on average; about 12 percent of provincial GDP among other provinces.
  - Provincial fiscal revenue variation: from 8‒14 percent of provincial GDP as of 2012.
  - Local government tax revenues (including portion of shared taxes) account for nearly half of total government revenue; local government spending obligations are roughly two-thirds of total government expenditure.
  - Many local governments rely on land sales and off-budget borrowing via LGFVs.
  - Local government debt, on average, rose to nearly 70 percent of total fiscal revenue in 2013 (or 23 percent of provincial GDP).
  - Adding government guaranteed and contingent liabilities would push the average to about 33 percent of provincial GDP, and to over 60 percent of GDP in some provinces.
  - Augmented net borrowing was 7½ percent of GDP in 2013.
  - Off-budget activity through LGFVs increased markedly during 2009–13.
- Public debt and audit reconciliation:
  - Staff estimate of general government debt: As of end-2012: 37.4 (percent of GDP); As of end-2013: 39.4 (percent of GDP).
  - NAO total debt as of end-2012 (NAO): 53.5 (percent of GDP).
  - Staff revised augmented debt estimate for 2012: 50.3 / 18.1 / 32.2 (table-format entries preserved verbatim from source).

### IV. INDIVIDUAL INCOME TAX (IIT) AND SOCIAL SECURITY CONTRIBUTIONS (SSC) — distributional effects
- IIT structure and parameters:
  - Employment tax schedule progressive; highest marginal tax rate 45 percent at the very top (about 35 times the national average wage).
  - Standard deduction: CNY 42,000 (current); illustrative reform proposes reducing to 12,000RMB.
  - Over 80 percent of workers are not liable to pay IIT given basic personal allowance of RMB 42,000 (illustrative calculation).
  - IIT accounts for about 5 percent of total tax revenue.
  - Business income of individuals taxed on progressive schedule with marginal rates 5 percent to 35 percent.
  - Professional income taxed about 16 percent on average; capital income taxed about 20 percent on average; rental income taxed at 10 percent (net of a 20 percent deduction).
  - Exemptions include interest from government bonds and bank deposit accounts, income from agricultural activities, pension contributions and pension income at retirement.
- SSC design and incidence:
  - Contributions withheld from wages and remitted by employers, on average about 11 percent of gross wage for employees (or net of IIT at near 9 percent); exact percentages vary across provinces and localities.
  - Imputed minimum earnings for SSC set at 60 percent of the previous year’s average wage of the locality; contribution cap set at 3 times the locality average wage.
  - It is estimated around 30 percent of the urban labor force earns below the 60 percent threshold in several large cities.
  - Around one quarter of the urban labor force was not covered by social security contributions in 2010.
  - SSC structure and imputed earnings imply the effective contribution rate is very regressive in employee income; SSC constitute over 90 percent of direct tax liabilities for a majority of households.
  - Effective tax schedule regressive at employment income below 70 percent of average wage income; households in lowest income quartile face a much higher effective tax rate than higher-income groups.

### V. VALUE-ADDED TAX (VAT) AND OTHER CONSUMPTION TAXES
- Ongoing reform:
  - Transition from business operation tax to VAT on services.
  - Multiple VAT rates in transition: goods 13–17 percent; services 6-11 percent.
  - Small businesses: simplified VAT scheme at 3 percent on output without input deductions.
  - Estimated average effective VAT rate around 11–14 percent.
- Policy objectives:
  - Complete transition to VAT on services; consider reducing number of rates, ideally to a single VAT rate.
  - Complementary policies (targeted expenditure programs, investment credits, accelerated depreciation) preferred for distributional/sectoral goals.

### VI. BOX 1 — ILLUSTRATIVE REVENUE PROJECTIONS (methodology, measures, and effects)
- Methodology and key assumptions:
  - Based on simple assumption of no behavioral changes and constant enforcement levels.
  - Calculations use current IIT and social security revenues and CHFS 2011 nationally representative earnings data.
- Proposed measures and illustrative revenue effects (In percent of GDP; figures preserved exactly):
  - Lower the personal deduction from 42,000RMB to 12,000RMB — 0.3
    - Distributional note: almost 25 percent of the lowest earning workers would not have to pay any IIT at this level.
  - Shorten tax brackets — 2.2
    - Distributional note: over 50 percent of workers pay a 5 percent marginal tax rate or lower; around 75 percent pay less than 20 percent; top marginal rate of 45 percent would apply to less than 10 percent of top wage earners.
  - Increase marginal rates from 3-10-20-25-30-35-45 percent to 5-15-25-35-45 percent — 0.6
  - Remove SSC income imputation — -0.5
    - Rationale: would lower revenues but partially offset by deductibility of SSC for IIT purposes.
  - Combined total of these measures — 2.6
    - Text summary: combined total of all these measures would be between 2.5 to 3 percent of GDP.
- Current IIT bracket shares and illustrative reform bracket shares (selected entries preserved exactly):
  - Current Regime (Gross Labor Income Between (RMB) — IIT Marginal Tax Rate — Share of Taxpayers)
    - 0            47,191             0               80.7
    - 47,192        67,416        3        8.2
    - 67,417       107,865       10       5.9
    - 107,866      168,539      20      3.5
    - 168,540      519,101      25      1.7
    - 519,102      788,764      30      0.1
    - 788,765     1,125,843     35     0.0
    - Over 1,125,843 45 0.1
  - Illustrative Reform (Gross Labor Income Between (RMB) — IIT Marginal Tax Rate — Share of Taxpayers)
    - 0             13,483            0            24.7
    - 13,484         24,719        5        29.3
    - 24,720         35,955       15       17.2
    - 35,956         52,809      25      12.6
    - 52,810         80,899      35      7.9
    - Over 80,900      45      8.3

### VII. BOX 1 CHARTS — SUMMARY OF REFORM IMPACTS AND FISCAL SCENARIOS
- Revenue potentials (figures preserved exactly):
  - Transition and extension of VAT to services: 0.5-1.0 percent of GDP
  - More progressivity of personal income tax and reduction in social security contributions: 2.0-3.0 percent of GDP
  - Property tax: 1.0-1.5 percent of GDP
  - Environment tax: 1.0 percent of GDP
  - Overall revenue measures estimated to generate 4.5-6.5 percent of GDP
- Additional illustrative figures:
  - Transition and extension of VAT to services could be implemented as a single VAT rate around 12–14 percent for goods and services; could raise an additional ½–1 percent of GDP over time.
  - Introducing a recurrent property tax could raise 1.0-1.5 percent of GDP over time; bringing property tax revenue close to the OECD average could raise additional revenue of the order of 1‒1½ percent of GDP.
  - Environmental tax reform could raise about 1.0 percent of GDP; combined pollution-pricing reforms could raise revenues to levels comparable to the OECD average of about 2½ –3 percent of GDP (an increase of 1‒1½ percentage points).
- Social spending pressures and projections:
  - Public spending on pension could double by 2030 based on World Bank’s projections.
  - Health care spending could increase by 50 percent solely as a result of demographic trends.
  - Proposed reform scenario could aim to increase public expenditures by:
    - Education: around 1 percent of GDP
    - Health care: 2‒3 percent of GDP
    - Pension/legacy costs: another 3–4 percent of GDP
  - Additional social expenditures could sum to around 7‒8 percent of GDP by 2030.
  - By 2020 social spending would increase by 5‒6½ percent of GDP to reach 15‒16 percent of GDP (assuming a gradual approach).
- Fiscal aggregation and net adjustments (Table 3 consolidated figures preserved):
  - Revenue measures: 4.5-6.5 percent of GDP
  - Expenditure measures: 0.5-1.0 percent of GDP
  - Reduction of local government off-budget spending: -5.5 percent of GDP
  - Increase of social spending: 5.0-6.5 percent of GDP
    - Education: 1.0 percent of GDP
    - Health: 2.0-2.5 percent of GDP
    - Social security: 2.0-3.0 percent of GDP
  - Net adjustment from above measures: 4.0-5.5 percent of GDP
  - Financing towards consolidation of augmented fiscal balance: -5.0 percent of GDP
- Expected macro outcomes:
  - Package could generate additional fiscal space of 4.5–6.5 percent of GDP.
  - Combined with cuts in off-budget public infrastructure spending, package could make room for a gradual but considerable hike in social spending while ensuring sustainability.
  - Implementing the full menu would put government debt on a firmly downward path over the medium term; a slow reform baseline implies augmented government debt would continue to rise.
  - Overall package would achieve a consolidation in the augmented deficit of about 1 percentage point of GDP a year over the medium term, with annual pace calibrated to macroeconomic conditions.

### VIII. POLICY RECOMMENDATIONS AND SEQUENCING
- Strengthen progressivity of employment income taxation:
  - Make higher IIT brackets applicable to a broader set of high-income earners combined with stronger enforcement and compliance.
  - Lower the basic personal allowance to broaden the tax base while preserving progressivity at low income levels.
- Reform social security contributions:
  - Reduce regressive SSC rates for low-income workers, implemented at an appropriate time and pace while ensuring sustainability.
  - Consider parametric pension changes and transfer welfare and legacy components to the general government budget.
  - Use actual income of low-income workers in SSC premium calculations instead of imputed minimum earnings.
  - Improve pension portability across schemes and regions; extend portability guidelines and fuller integration of pension schemes over time.
- Complete VAT transition and rationalize rates:
  - Continue and complete transition from business operation tax to VAT on services.
  - Broaden VAT base and consider unifying/reducing number of rates toward a single VAT rate.
  - Use complementary policies (targeted expenditure programs, investment credits, accelerated depreciation under CIT) for distributional or sectoral objectives.
- Strengthen environmental taxation:
  - Move from fee-based, fragmented charges to better-designed environmental taxes targeting externality content (e.g., carbon content).
  - Increase levies on local air pollutants (SO2, NOX, particulates) and consider upgrading legal status to full taxes.
  - Further increase excise duties on gasoline and other petroleum products to better reflect externality costs.
  - Calibrate vehicle taxes to reflect emission levels (options include ad valorem excise and revenue-neutral ‘feebate’ systems).
- Improve local fiscal alignment and risk management:
  - Rebalance revenue sharing and transfers to reduce reliance on land sales and off-budget borrowing by local governments.
  - Strengthen oversight and bring local government borrowing on-budget (pilot municipal bond issuance, budget law revisions requiring disclosure and warning systems).
  - Reduce public investment and LGFV activity by about 5‒6 percentage points of GDP over the medium term to contain local government borrowing risks.
- Property-tax design and sequencing:
  - Phase in recurrent property tax gradually; ensure nation-wide registry and value assessment framework before full rollout.
  - Initial consolidation of transaction-based taxes into recurrent property tax could be revenue neutral.

### IX. APPENDIX TABLES — SELECTED DATA POINTS (preserved as in source)
- Sub-national tax revenue notes and figures: total of sub-national gov. tax revenues: 4,732 (RMB billions) / 23.3 / 32.9 / 31.1 / 12.7 / 9.1 (table-format entries preserved verbatim).
- Memorandum item: Land sales receipts 2/: 4,285 / 21.4 / 2.1 / 1.8 / 0.25 / 5.5 (entries preserved verbatim).
- Appendix Table 2 reconciliation entries and NAO fractions preserved verbatim in source.
- Recent reform timeline highlights preserved (2008, 2010, 2011, 2012, 2013 entries and pilot details).

*Source: _wp1566 - References .............................................................................................................*

### References .............................................................................................................

### _wp1566 - References .............................................................................................................

### I. INTRODUCTION
- Reform context:
  - In late 2013 following the Third Plenum of the Eighteenth Communist Party, China put forward an ambitious and comprehensive reform blueprint covering financial, fiscal, external, and structural reforms to help transition to high income status.
  - Fiscal reforms are an integral part of the blueprint and are key for achieving more inclusive, green, and sustainable growth.
- Paper focus and contribution:
  - Focus: revenue reforms—tax policies to facilitate economic transition to high income status, promote fiscal sustainability, and make growth more inclusive and environmentally friendly.
  - Contribution: a menu of options for revenue reforms, illustrative budget impacts, and integration with other fiscal reforms to ensure public finance sustainability.
- High-level estimates and objectives:
  - Revenue reforms could lift revenues by 4.5–6.5 percent of GDP over the medium term.
  - These reforms would provide room to address the buildup of risks in local government finances, and increase social spending, such as education and healthcare.
- Organization:
  - Section II: background of the tax system in China and local government finance challenges.
  - Section III: key revenue reform policies and budgetary impact.
  - Section IV: menu of options and how to implement them with other reforms to ensure fiscal sustainability, including reducing off-budget infrastructure spending by local governments and increasing social spending.
  - Section V: conclusion.

### II. TAX SYSTEM IN CHINA — Key Findings and Characteristics
- Revenue growth and composition:
  - Growth in nominal revenues in China on average has been about 20 percent, much higher than the nominal growth in GDP.
  - Tax revenue has accounted for about 22 percent of GDP in 2013, somewhat lower than the average 34 percent of GDP across the OECD.
  - Indirect taxes on goods and services, including the VAT and business operation tax, account for more than half of tax revenue.
  - Direct taxes such as personal income tax and corporate income tax account for a small fraction of tax revenue, much lower than the OECD average.
  - China has also relied more on nontax revenues (government funds, fees, fines and income from the SOE ownership), which are often levied by local governments.
  - After adjusting for nontax revenue and net land sale proceeds (about 2¾ percent of GDP), the overall tax burden is similar to the tax-to-GDP ratio for other Asian economies such as Australia, Japan, and Korea.
- Fiscal design and procyclicality:
  - The budget system often aims for an annual balanced budget, reinforcing procyclicality: higher fiscal revenue is usually matched by increasing expenditure rather than carrying forward the surplus.
  - A plan to introduce a multi-year budget and strengthen the medium-term fiscal framework under the new budget law effective in January is noted as a measure that would help mitigate procyclicality.
  - The central government maintains a budget stabilization fund; the size of the budget stabilization fund is noted but the numeric value is not provided in the excerpt.
- Redistribution and inequality:
  - Income inequality (Gini coefficient) was below 0.3 in the mid-1980s and has risen to near 0.5 in recent years.
  - Individuals at the highest income decile earn more than 16‒18 times those at the lowest decile.
  - The redistributive effect of taxes and transfers is relatively limited; fiscal policy appears to contribute relatively little to narrowing rising inequality, as reflected in the difference between Gini coefficients before and after taxes and transfers.
  - Reliance on indirect taxes and the regressive design of direct taxes (particularly social security contributions) mean low-income earners often pay a much higher effective tax rate than higher income households.
  - Quality and access to social services and social safety nets vary according to hukou (household residency) status, reinforcing disparities and weakening the redistributive effect of fiscal policy.

### III. Policy Options Highlighted
- Suggested tax reform options:
  - Strengthen progressivity of the individual income tax and social security contribution systems.
  - Continue the transition to a value-added tax (VAT) on services.
  - Gradually introduce a recurrent property tax.
  - Strengthen environmental taxation.
- Objectives of reforms:
  - Improve economic efficiency and lift living standards, especially for lower income groups.
  - Better align local revenue and spending responsibilities.
  - Provide fiscal space to address local government financial risks and to increase social spending.
- Implementation considerations:
  - Revenue reforms can be integrated with other fiscal measures, including reducing off-budget infrastructure spending by local governments and increasing social spending, to ensure fiscal sustainability.

*Source: _wp1566 - References .............................................................................................................*

### 0.2 percent of GDP), however, is small relative to the size of the budget.

### _wp1566 - 0.2 percent of GDP), however, is small relative to the size of the budget.

### Fiscal structure and revenue composition
- China: VAT and consumption tax, 28.7; VAT and consumption tax for imports, 10.8; Business tax, 13.3; Personal income tax (PIT), 5.1; Corporate income tax, 17.4; Other tax, 10.7; Nontax revenues, 14.5 (in percent of 2013 total revenues).
- China: Tax Revenue Sharing Arrangement between Central and Sub-national government (in percent of 2013 total tax revenues and social security contributions): Central taxes, 12.2; Subnational taxes, 24.9; Shared taxes - central government, 28.9; Shared taxes - sub-central government, 13.6; Social security contributions, 20.4.
- VAT and consumption tax and other categories over time are sizable shares of general government revenues (figures shown for 1994–2013).
- Recurrent property- and land-related taxes account for about 7 percent of tax revenue (or 1.5–2 percent of GDP).
- Environmental and resource levies exist but total collection is low relative to OECD countries; enforcement and design shortcomings reduce effectiveness.

### Local government finances and fiscal federalism
- Tax revenues account for 18 percent of GDP in large cities on average, compared to about 12 percent of provincial GDP among other provinces.
- Variation in provincial fiscal revenue ranges from 8‒14 percent of provincial GDP as of 2012.
- Municipalities and provinces in coastal areas often run a surplus while deficits often occur in inner regions; transfers from the central government play a significant role in local government finances.
- Local government tax revenues (including the portion of shared taxes) account for nearly half of total government revenue, while local government spending obligations are roughly two-thirds of total government expenditure.
- Many local governments rely on land sales and off-budget borrowing through local government financing vehicles (LGFVs) to finance budgets.
- Revenue sharing: tax revenue broadly consists of (i) central taxes (trade-related duties, trade-related VAT, luxury taxes, export rebates), (ii) local government taxes (property-related taxes, business operation taxes), and (iii) shared taxes (personal and corporate income taxes and the VAT excluding trade-related VAT).
- Fiscal position across subnational governments (in percent of 2013 GDP) shows variation by level (central, consolidated local, provincial, prefecture, county, township) in government tax revenues, nontax revenues, transfers, expenditures, and balances.

### Individual income tax (IIT), social security contributions (SSC), and distributional effects
- IIT employment tax schedule is progressive; highest marginal tax rate is 45 percent at the very top of the income distribution (about 35 times the national average wage).
- A standard deduction of CNY 42,000 is allowed in calculating taxable income.
- Illustrative calculations indicate over 80 percent of workers are not liable to pay the IIT given the high basic personal allowance of RMB 42,000.
- IIT accounts for about 5 percent of total tax revenue in China.
- Business income of individuals taxed on progressive schedule with marginal rates varying between 5 percent and 35 percent.
- Professional income taxed at about 16 percent on average; capital income taxed at about 20 percent on average; rental income taxed at 10 percent (net of a 20 percent deduction).
- Several income sources are exempt from IIT, including interest from government bonds and deposit accounts with Chinese banks, income from agricultural activities, pension contributions and pension income at retirement.
- SSCs: contributions withheld from wages and remitted by employers, on average about 11 percent of gross wage for employees (or net of IIT at near 9 percent), exact percentages vary across provinces and localities.
- Imputed minimum earnings for SSC are set at 60 percent of the previous year’s average wage of the locality; contribution cap set at 3 times the locality average wage.
- It is estimated that around 30 percent of the urban labor force earns below the 60 percent threshold in several large cities.
- Around one quarter of the urban labor force was not covered by social security contributions in 2010.
- SSC structure and imputed earnings imply the effective contribution rate is very regressive in employee income; SSC constitute over 90 percent of direct tax liabilities for a majority of households.
- Household-level findings: the effective tax schedule is regressive at employment income below 70 percent of average wage income; households in the lowest income quartile face a much higher effective tax rate than higher-income groups.
- Composition of statutory and effective average tax burdens shows high burdens for households at the bottom of the income distribution when SSC and IIT are combined.

### Value-added tax (VAT) and other consumption taxes
- Ongoing reform: transition from business operation tax (turnover tax) to VAT on services.
- Multiple VAT rates apply in transition: goods 13–17 percent; services 6-11 percent.
- Small businesses subject to simplified VAT scheme at 3 percent on output without input deductions.
- Preliminary pilot evidence: tax burden on suppliers was not increased for a majority of small and medium-sized enterprises; reform led to a decrease in revenues collected for many SMEs and reportedly increased investment in the sector.
- Estimated average effective VAT rate around 11–14 percent (between 17 percent VAT rates on goods and 6–11 percent rates applied to services).
- Policy objective: once transition complete, consideration could be given to reducing number of rates, ideally to a single VAT rate; other policy tools (targeted expenditure programs, investment credits, accelerated depreciation) could meet distributional or sectoral objectives.

### Key revenue and reform-related statistics and constraints
- Property- and land-related taxes: about 7 percent of tax revenue (1.5–2 percent of GDP).
- Social security contributions share in tax and social security contributions: 20.4 (percent of 2013 total tax revenues and social security contributions).
- Estimates indicate that broader tax reform (IIT base broadening and/or rate adjustments) could raise an additional 2‒3 percent of GDP in revenue.
- Pilot property tax initiatives in Shanghai and Chongqing (introduced 2011) generated modest revenue due to exemptions and enforcement challenges.
- Environmental taxes and pollution fees are presently low; corrective fuel/coal tax potential revenue and pollution-damage estimates indicate substantial externality costs but current levies are weak and fragmented.

### Policy recommendations and reform priorities (as described in the source)
- Strengthen progressivity of taxation on employment income:
  - Make higher IIT brackets applicable to a broader set of high income earners combined with stronger enforcement and compliance.
  - Lower the basic personal allowance to broaden the tax base to include more middle income workers while preserving progressivity at low income levels.
- Reduce regressive social security contribution rates for low-income workers, implemented at an appropriate time and pace while ensuring sustainability of social security:
  - Consider parametric changes to the pension system and transfer welfare and legacy components to the general government budget.
  - Use actual income of low-income workers in calculation of SSC premiums instead of imputed minimum earnings to avoid extraordinarily high contribution rates for low earners.
  - Improve pension portability across schemes and regions; extend portability guidelines and fuller integration of pension schemes over time.
- Continue and complete transition from business operation tax to VAT on services:
  - Broaden VAT base and consider unifying and reducing the number of rates, ideally toward a single VAT rate.
  - Use complementary policies (targeted expenditure programs, investment credits, accelerated depreciation under CIT) to achieve distributional or sectoral objectives rather than multiple VAT rates.
- Strengthen environmental taxation:
  - Move from fee-based, fragmented charges to better-designed environmental taxes that target externality-generating content (e.g., carbon content) and improve enforcement and alignment of incentives across agencies.
- Improve alignment of local revenue and spending obligations:
  - Rebalance revenue sharing and transfers to reduce reliance on land sales and off-budget borrowing by local governments.
  - Consider measures to better align the transition of business operation tax to VAT with local government revenue needs to avoid intensifying shortfalls.

*Source: IMF staff analysis and figures in the supplied content.*

### Box 1. Illustrative Revenue Projections

### Box 1. Illustrative Revenue Projections

### Methodology and key assumptions
- Projected revenue gains are illustrative and based on the simple assumption of no behavioral changes in either labor supply or other adjustments in reported taxable income.
- Enforcement levels are held constant in calculations.
- Calculations are based on current IIT and social security revenues in China and on the nationally representative earnings data taken from the China Household Finance Survey (CHFS) for the year 2011.
- The reform proposal focuses on measures aimed at increasing IIT revenues and improving the progressivity of the tax system on labor income.

### Proposed reform measures and illustrative revenue effects
- Lower the personal deduction from 42,000RMB to 12,000RMB
  - Rationale: ensure more middle-class earners pay the IIT and that higher-earning workers pay IIT on a larger share of their earnings.
  - Distributional note: Based on CHFS survey data, this level would still ensure that almost 25 percent of the lowest earning workers would not have to pay any IIT.
  - Illustrative revenue effect: 0.3 (In percent of GDP)
- Shorten tax brackets
  - Rationale: current marginal tax brackets are very wide so top rates apply to a very small fraction of the labor force; shortening brackets so higher rates start applying at lower earnings could generate significant revenue.
  - Distributional note: the recalibration would still ensure that over 50 percent of workers pay a 5 percent marginal tax rate or lower and around 75 percent of workers pay less than 20 percent. The top marginal rate of 45 percent would apply to less than 10 percent of top wage earners.
  - Illustrative revenue effect: 2.2 (In percent of GDP)
- Increase marginal rates from 3-10-20-25-30-35-45 percent to 5-15-25-35-45 percent
  - Illustrative revenue effect: 0.6 (In percent of GDP)
- Remove SSC income imputation
  - Rationale: current imputation system generates a very high tax burden for the poorest workers and results in a very regressive labor tax wedge; transition to an effective earnings system would result in lower revenues but would be partially offset by the deductibility of SSC for IIT purposes.
  - Illustrative revenue effect: -0.5 (In percent of GDP)
- Combined total of these measures
  - Total revenue change: 2.6 (In percent of GDP)
  - Text summary: The combined total of all these measures would be between 2.5 to 3 percent of GDP.

- Footnote: "The deduction could also have been converted to a tax credit along with other appropriate parametric changes to the marginal rate schedule to generate similar revenue projections. It should be noted that in general holding everything else constant, a credit is cheaper and more progressive than a deduction."

### Illustrative revenue-change table (as reported)
- Tax Measure (In percent of GDP)
  - Lower the personal allowance from 42,000RMB to 12,000RMB — 0.3
  - Shorten tax brackets — 2.2
  - Increase marginal rates from 3-10-20-25-30-35-45 percent to 5-15-25-35-45 percent — 0.6
  - Remove SSC income imputation — -0.5
  - Total revenue change — 2.6

### IIT parameters under current regime and illustrative reform (selected bracket and share details)
- Current Regime (Gross Labor Income Between (RMB) — IIT Marginal Tax Rate — Share of Taxpayers)
  - 0            47,191             0               80.7
  - 47,192        67,416        3        8.2
  - 67,417       107,865       10       5.9
  - 107,866      168,539      20      3.5
  - 168,540      519,101      25      1.7
  - 519,102      788,764      30      0.1
  - 788,765     1,125,843     35     0.0
  - Over 1,125,843 45 0.1
- Illustrative Reform (Gross Labor Income Between (RMB) — IIT Marginal Tax Rate — Share of Taxpayers)
  - 0             13,483            0            24.7
  - 13,484         24,719        5        29.3
  - 24,720         35,955       15       17.2
  - 35,956         52,809      25      12.6
  - 52,810         80,899      35      7.9
  - Over 80,900      45      8.3

### Distributional impact and illustrative interpretation
- Current structure effectively exempts from any tax a very large proportion of wage earners, even though some of these have relatively high incomes.
- The reform’s parametric changes shift the average tax burden away from the lowest earning workers toward those at the top of the income distribution.
- Figures (described in source) illustrate marginal and average tax rates across income quantiles for a nationally representative sample of urban households in 2011.

*Source: IMF staff calculations based on IBFD, CEIC, and China Household Finance Survey 2012.*

### Box 1 Charts: China: IIT and SSC Reform

### Box 1 Charts: China: IIT and SSC Reform

### Summary of proposed tax and revenue reforms
- Transition and extension of VAT to services could be implemented as a single VAT rate around 12–14 percent for goods and services; this could raise an additional ½–1 percent of GDP in revenue over time.
- More progressivity of personal income tax and reduction in social security contributions are expected to yield 2.0-3.0 percent of GDP in additional revenue.
- Introducing a recurrent property tax (beyond current pilots) could raise 1.0-1.5 percent of GDP over time; bringing property tax revenue close to the OECD average could raise additional revenue of the order of 1‒1½ percent of GDP.
- Environmental tax reform could raise about 1.0 percent of GDP; combined pollution-pricing reforms could, over time, raise revenues to levels comparable to the OECD average of about 2½ –3 percent of GDP (an increase of 1‒1½ percentage points).
- Overall revenue measures are estimated to generate 4.5-6.5 percent of GDP.

### Key fiscal figures and current tax baselines
- VAT revenue and business operation tax in 2013 was 8.1 percent of GDP.
- Gross land sale revenue was sizeable at about 7 percent of GDP in 2013 (net land sale revenue was 2½–3 percent of GDP after accounting for expenses related to city construction, land development, and compensation for relocation).
- The effective tax rate on gasoline could increase from its current level of 40¢ per liter to roughly 55¢ per liter (comparative levels: Japan 75¢ per liter; South Korea 85¢ per liter).

### Local government finances and risks
- Local government debt, on average, has risen to nearly 70 percent of total fiscal revenue in 2013 (or 23 percent of provincial GDP).
- Adding government guaranteed and contingent liabilities would push the average to about 33 percent of provincial GDP, and to over 60 percent of GDP in some provinces.
- Augmented net borrowing was 7½ percent of GDP in 2013.
- Off-budget activity through LGFVs contributed materially to investment and could strain local finances; investment and LGFV liabilities increased markedly during 2009–13.
- Some provinces derive one-fifth of tax revenue (excluding land sale) from real estate and related sectors.

### Social spending pressures and projections
- Public spending on pension could double by 2030 based on World Bank’s projections.
- Health care spending could increase by 50 percent solely as a result of demographic trends.
- The proposed reform scenario could aim to increase public expenditures by:
  - Education: around 1 percent of GDP
  - Health care: 2‒3 percent of GDP
  - Pension/legacy costs: another 3–4 percent of GDP to fully finance the basic old-age pension and gradually meet legacy costs
- Additional social expenditures could sum to around 7‒8 percent of GDP by 2030 (including demographic effects).
- Assuming a gradual approach, by 2020 social spending would increase by 5‒6½ percent of GDP to reach 15‒16 percent of GDP.

### Menu of fiscal adjustment options (Table 3 consolidated)
- Revenue measures: 4.5-6.5 percent of GDP
  - Transition and extension of VAT to services: 0.5-1.0 percent of GDP
  - More progressivity of personal income tax and reduction in social security contributions: 2.0-3.0 percent of GDP
  - Property tax: 1.0-1.5 percent of GDP
  - Environment tax: 1.0 percent of GDP
- Expenditure measures: 0.5-1.0 percent of GDP
- Reduction of local government off-budget spending: -5.5 percent of GDP
- Increase of social spending: 5.0-6.5 percent of GDP
  - Education: 1.0 percent of GDP
  - Health: 2.0-2.5 percent of GDP
  - Social security: 2.0-3.0 percent of GDP
- Net adjustment from above measures: 4.0-5.5 percent of GDP
- Financing towards consolidation of augmented fiscal balance: -5.0 percent of GDP

### Policy design and sequencing recommendations
- Phase in recurrent property tax gradually and ensure a nation-wide registry and value assessment framework before full rollout; initial consolidation of transaction-based taxes into a recurrent property tax could be revenue neutral.
- Introduce tax on fossil fuel carbon emissions upstream (at coalmine, energy plant, or petroleum refinery) to reduce administrative burden and provide economy-wide incentives to reduce emissions.
- Increase levies on local air pollutants (SO2, NOX, small particulates) and consider upgrading their legal status to full taxes to facilitate enforcement.
- Further increase excise duties on gasoline and other petroleum products to better reflect externality costs.
- Calibrate vehicle taxes to reflect emission levels (options include an ad valorem excise on vehicle value and revenue-neutral ‘feebate’ systems based on emission rates).
- Strengthen oversight and bring local government borrowing on-budget (pilot municipal bond issuance, budget law revisions requiring disclosure and warning systems).
- Reduce public investment and infrastructure spending (including LGFV activity) by about 5‒6 percentage points of GDP over the medium term to return to pre-global financial crisis levels and contain local government borrowing risks.
- Gradually expand and strengthen pension and health insurance coverage to improve financing and efficiency of social programs.

### Expected fiscal and macro outcomes
- The package of revenue and expenditure reforms could generate additional fiscal space of 4.5–6.5 percent of GDP.
- Combined with cuts in off-budget public infrastructure spending, the package could make room for a gradual but considerable hike in social spending while ensuring sustainability.
- Implementing the full menu of reforms would put government debt on a firmly downward path over the medium term; a slow reform baseline implies augmented government debt would continue to rise.
- The overall package would achieve a consolidation in the augmented deficit of about 1 percentage point of GDP a year over the medium term, with annual pace calibrated to macroeconomic conditions.

*Source: Box 1 Charts: China: IIT and SSC Reform (excerpt).*

### Appendix Table 1. Distribution of Fiscal Revenue Across Subcentral Governments

### Appendix Table 1. Distribution of Fiscal Revenue Across Subcentral Governments

### Distribution of tax revenues across sub-national tiers (in RMB billions; percent shares where shown)
- Table header context: Provincial / Prefecture / County / Township
- Value-added tax: 264 / 219 / 68 / 67 / 41.9 / 32.0 / 31.9 / 16.6 / 1.3
- Business tax / Operations: 157 / 520 / 155 / 429 / 29.2 / 30.5 / 29.1 / 11.3 / 3.0
- Urban maintenance and development tax: 313 / 192 / 93 / 6.4 / 44.5 / 36.1 / 130.6
- Corporate income tax: 1965 / 1208 / 757 / 37.8 / 31.1 / 23.8 / 11.5
- Personal income tax: 582 / 349 / 233 / 334.6 / 31.2 / 25.1 / 90.4
- Property tax: 563 / 563 / 837 / 37.9 / 39.7 / 14.5 / 1.1
- Resource tax: 908 / 619.4 / 16.7 / 37 / 26.9 / 0.2
- Other tax: 601 / 295 / 726 / 26.3 / 22.2 / 40.7 / 20.7 / 1.1
- Total of sub-national gov. tax revenues: 4732 / 23.3 / 32.9 / 31.1 / 12.7 / 9.1
  - in percent of GDP: 9.1 / 2.1 / 3.0 / 2.8 / 1.2

(Note: table entries preserved as presented in source; header indicates figures in RMB billions and percent shares.)

### Non-tax revenues and components (in RMB billions; percent as presented)
- Operating Expense in Administration D: 458 / 384 / 2035.6 / 31.1 / 28.9 / 4.4 / 0.8
- Penalty Income: 156 / 415 / 236.4 / 31.8 / 27.3 / 4.5 / 0.3
- Special Project Income: 323 / 412 / 8216.7 / 33.3 / 50.0 / 0.0 / 0.5
- Other Income: 727 / 205 / 52241.2 / 29.4 / 23.5 / 5.9 / 1.0
- Nontax revenues for sub-national government: 1376 / 35.6 / 31.1 / 28.9 / 4.4 / 2.7
- Revenue of sub-national gov. in percent of GDP (as of 2012): (table indicates presence of percent-of-GDP measures; entries preserved above)

### Memorandum item: Land sales receipts (as reported)
- Land sales receipts 2/: 4285 / 21.4 / 2.1 / 1.8 / 0.25 / 5.5
- For local governments, the receipts consist of:
  - (i) compensation from "newly constructed land use" fund RMB 77.3 bn;
  - (ii) compensation from the "Transfer of usage rights for government-owned land" fund RMB 2665 bn;
  - (iii) revenues from government owned land fund RMB 89.7 bn;
  - (iv) cultivation fund of agricultural land RMB 19.5 bn.
- Sources: CEIC and OECD (2013).
- Notes:
  - 1/ Distribution across sub-national governments based on local fiscal statistical yearbook for 2009.
  - 3/ The distribution across sub-central governments is based on the relative share in 2009.

### Revenue shares and presentation notes
- Headings in source include: "Revenue of sub-national gov. in percent of GDP", "in percent of sub-national gov. non tax revenue 1/", "As of 2012", "in RMB billions", "Sub-national governments 1/", "in percent of total sub-national gov. tax revenue", "General gov.", "Central gov.", "Local gov.", "in percent of 2012 national GDP 3/".
- Source table indicates some figures are "As of end-2012; in percent of GDP".

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### Appendix Table 2. Reconciliation of Staff Estimates and National Audit Office on General Government Debt

### Staff estimates and revisions (percent of GDP)
- Last year's staff report (IMF Country Report No. 13/211): 46.2 / 14.4 / 31.8
- Revised staff estimate this year for debt in 2012: 50.3 / 18.1 / 32.2
- Staff estimate of general government debt:
  - As of end-2012: 37.4
  - As of end-2013: 39.4
- Staff notes:
  - 1/ Augmented debt expands the perimeters of general government to include off-budget activity and local government financing vehicles activity.
  - 2/ Staff estimate of augmented debt in 2012 excluded debt by China Railway Corporation and debt for bank recapitalization (about 7 percent of GDP in total).
  - 3/ Staff estimate of general government debt is based on applying a similar share of total debt as government debt according to the NAO audit. Staff estimate excludes the debt by China Railway Corporation.

### National Audit Office (NAO) reported figures (percent of GDP and components)
- Total debt as of end-2012 (NAO): 53.5
- NAO detailed split (as presented):
  - Explicit debt / Guaranteed debt / May incur liabilities:
    - 22.9 / 18.2 / 0.5 / 4.2 / 5/ 30.6 / 18.5 / 4.8 / 7.3 (table entries preserved verbatim as in source)
- Government debt as of end-2012 (NAO applied fraction): 39.4 / 18.9 / 18.2 / 0.1 / 0.6
  - additional entries: 20.5 / 18.5 / 0.9 / 1.1
- Memorandum item:
  - Fraction of contingent liabilities NAO considered as government debt: 19.1 / 14.6 / 19.1 / 14.6
- Notes from NAO and staff:
  - 4/ National Audit Office report (2013).
  - 5/ National Audit Office report included the debt raised by China Railway Corporation (4.2 percent of GDP) as a contingent liabilities.
  - 6/ National Audit Office report applied a fraction (19.1 percent of guaranteed debt and 14.6 percent of the liabilities that the government may be obliged to repay) of those debt as government debt, based on the historical data.

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### Contingent liabilities (presentation in source)
- Contingent Liabilities headings include: Central Government / Local Government / Contingent Liabilities / Total / Total
- Source: NAO; and IMF staff estimates.
- Context note: "Augmented debt expands the perimeters of general government to include off-budget activity and local government financing vehicles activity."

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### Appendix Table 3. Recent Tax Reform Initiatives in China (as of October, 2013)

### Transition from Business Tax to VAT (timeline and measures)
- 2008: The transition from business turnover tax to value-added tax was jointly approved by The State Council, MoF, and State Administration of Taxation.
- 2012:
  - The number of tax brackets was reduced from 9 to 7 with rates ranging from 3-45 percent.
  - A tax rate of 0.5-1.2 percent was introduced for residential properties in Shanghai and Chongqing. 4/
- 2013:
  - Beginning January, Shanghai was the first pilot area for the transition to VAT for transportation and modern services.
  - Pilots areas extended to 8 provinces from September to December.
  - Transition to VAT tax was extended to entire country for transportation and part of modern services in August.
- Authorities' current plan and initiatives 6/:
  - 1) Extend pilot areas for railway transportation and telecommunications; extend other services to include in pilot areas
  - 2) Complete the transition to VAT by 2015.
- Fund advice (2013 AIV): Support the transition to VAT as a support to rebalancing and promote efficiency.

### Corporate income tax
- 2010: Standardize tax rates between Chinese enterprises and foreign investment or enterprises.
- Current tax system note: A profit tax of 20-25 percent for enterprises.
- Authorities' current plan and initiatives: 1) Deepen the reform in social security (listed under corporate income tax column in source).

### Personal income tax
- Marginal tax rates on wage income range from 3-45 percent in 7 progressive scales.
- Tax rates for other personal income at about 20 percent. 3/ 4/
- Notes:
  - 3/ Income from sole proprietorship and contractual work carries a tax rate of 5-35 percent in 5 progressive scales.
  - 4/ Employees and employers also have social security contributions that range about 10-30 percent of employment income, respectively. Employment incomes are subject to a threshold between 60 percent to 300 percent of the previous year's local average income determined by local statistics departments.
- Authorities' current plan and initiatives: 1) Deepen the reform in social security.

### Property taxes
- 2011: Pilots to introduce property taxes for residential property approved.
- 2012: Pilots to establish property tax pilots; a tax rate of 0.5-1.2 percent was introduced for residential properties in Shanghai and Chongqing. 4/
- 2013: Plan to expand the scope and pilot areas for introducing property tax but timing is not announced.
- Source details from table:
  - Real estate tax levied in the form of urban land use, land appreciation, and properties other than privately-owned residential units, property contracts based on use and transactions.
  - Tax on privately-owned residential property was rolled out in several pilot areas. 5/
  - 4/ A tax of 0.5-1.2 percent was introduced for single-family houses and high-end apartments in Chongqing, while a property tax of 0.6 percent was levied on newly purchased properties for residents who has two or more properties and newly purchased properties for nonresidents in Shanghai.
- Fund advice (2013 AIV): Support the property tax that help contain speculation in the real estate sector and boost local government revenues.

### Current tax system summary (as presented)
- Business tax: Tax rate of 3-5 percent on business tax based on turnover and 5-20 percent for entertainment services.
- VAT: A standard VAT tax rate of 17 percent was applied on goods and 6-11 percent on selected services. 2/
  - 2/ The 17-percent VAT rate is levied on the tangible goods, though some items are subject to 13 percent rate. The 11 percent rate is levied on transportation services and the 6 percent rate is levied on R&D, technological, cultural, logistical and consultative services.
- Personal income: Marginal tax rates on wage income range from 3-45 percent in 7 progressive scales. Tax rates for other personal income at about 20 percent. 3/ 4/

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*Appendix Tables and notes as provided in the source PDF.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp1566.pdf_