Saturday, March 5, 2011

Who has a more equal personal tax system? China or USA?

“China will raise the threshold of personal income tax amid the rising cost of living, a move aimed at reducing the burden of middle and low-income people and expanding domestic consumption, Premier Wen Jiabao said on Sunday."

(Higher tax threshold to assist poor on way, People's Daily Online)

Recently, whether the government should raise the personal income-tax threshold has been a hot issue in China, which can reflect the necessary to relieve burden of low-income people and to reduce inequality situation between rich and poor in China. It looks like a really sounding proposal. However, can we achieve our goal by increasing the personal income-tax threshold?

Individuals in China currently fall under nine different tax brackets-ranging from a minimum tax rate of 5% to a peak rate of 45%- depending on their income levels. The minimum threshold for personal income tax is 2,000 yuan ($304) per month. Increasing tax threshold, for example to 3,000 yuan, means that people who earn below 3,000 yuan don’t need to pay tax anymore. As we learned from class, the highest marginal rate of personal income tax in the USA is 35%. Comparing 45% in China and 35% in the USA, could we make a conclusion that China has a more equal personal income tax system? I would like to make some comparisons between personal income tax system in China and in the USA.

As we know, personal income tax is the most progressive tax comparing with property tax and sales tax, which indicates that personal income tax is not simply a tool for government to collect revenue, but most importantly is a tool for government to redistribute income. Personal income taxes contribute about 43% to federal government revenue in the USA every year. However, in China, the percentage of personal income taxes in government revenue is only about 6%. The biggest contribution for Chinese government revenue is from value-added tax, which may be the most regressive tax among tax system.

The reason of personal income tax is not a big contribution may come from that China does not have a national personal income tax collection system. Personal income tax is collected by provincial (state) and local governments in China, which increase the administrative cost. Not only it is hard for sharing information among local governments, but also it is hard to track people’s income earnings from other sources than wage, especially for high-income people.

In addition, the USA uses “Haig-Simon Income” method calculating income from different sources, and has progressive tax rates base on a total income. However, China adopts different personal income tax rates for different income sources. Especially, people do not need to pay their earnings from selling stock and other financial products in capital market, which is significantly beneficial to rich people in China. We can say that, the tax base of personal income tax in China mostly is labor’s wages. The most part of income of rich people definitely not from wages, and it is exempt somehow under current personal income tax structure in China.

The inequality is also resulted from exclusions. Chinese government regulates that some insurances and welfare, such as medical care insurance, endowment insurance and housing fund, can be excluded when paying personal income tax. The concern is that people who enjoy those insurances and welfare cannot be viewed as low-income people, most of whom even are middle-income or rich people in China. The low-income people mostly are farmers, migrant workers or people have no job or no stable job in China, who have no access to insurance or welfare. Therefore, personal income tax exclusions may increase inequality further.

Another point is that personal income tax system in China does not consider horizontal equity very. There is no regulation on personal exemptions considering expenditure burden, such as raising children, supporting parents or a big family. If two persons earning same income, but one is single and another one has a big family to support, their expenditure burdens are very different. We learned that the rationale of personal exemptions is to equalize taxes among families of different sizes. However, we do not have such regulation in China. This is extremely important for people from rural areas having a poor and big family to support.

From all the points above, we can find that it is not enough to simply comparing threshold or marginal tax rate to evaluate the equity of personal income tax structure. We still need to figure out how the government define income, exclusions and personal exemptions, how the government collect tax and provide tax credit.

Increasing tax threshold could be a way to relieve the burden of low-income people, but what we really need is to have a more equal structure of personal income tax in China. Or we need a national income tax collection system, which can collect more tax from the rich and provide tax credit to the low-income people.


  1. Nice post! Just a one little question: I think in China people actually need to pay taxes for the income from stock market??

  2. "In addition, the USA uses “Haig-Simon Income” method calculating income from different sources, and has progressive tax rates base on a total income."

    Bill Gates' wealth grew from $60 to $72 billion over the past 12 months. 99.9% of his income came from capital gains, taxed at 15%(long term) - 35% (short term). The beneficial treatment of this type of income, which accrues overwhelmingly to the top 10% of earners, needs to be included in any discussion of tax inequality.