51021-001: Reforming the System of Personal Income Tax and Social Security Contributions | Asian Development Bank

China, People's Republic of: Reforming the System of Personal Income Tax and Social Security Contributions

Sovereign (Public) Project | 51021-001 Status: Approved

1. The proposed knowledge and support technical assistance (TA) will develop policy recommendations for the People's Republic of China (PRC) to reform its personal income tax (PIT) and social security contribution (SSC) systems and provide training and capacity building for implementing these reforms. The TA request is part of a broader initiative by the government to adjust the tax system to bring it in line with the economic and social development status of the PRC. The TA will explore options to reform the system of PIT and SSC drawing on the experience and good practice in selected Organization for Economic Cooperation and Development (OECD) countries. Specifically, the TA aims to reform the PIT and SSC system with to (i) increase the contribution of PIT to tax revenue, and (ii) address distortions in the PIT and SSC system, notably those that affect the progressivity of the system and give rise to labor market segmentation.

Project Details

Project Officer
Zhuang, Jian East Asia Department Request for information
Country
  • China, People's Republic of
Modality
  • Technical Assistance
Sector
  • Public sector management
 
Project Name Reforming the System of Personal Income Tax and Social Security Contributions
Project Number 51021-001
Country China, People's Republic of
Project Status Approved
Project Type / Modality of Assistance Technical Assistance
Source of Funding / Amount
TA 9405-PRC: Reforming the System of Personal Income Tax and Social Security Contributions
Technical Assistance Special Fund US$ 300,000.00
Strategic Agendas Inclusive economic growth
Drivers of Change Governance and capacity development
Knowledge solutions
Sector / Subsector

Public sector management / Public expenditure and fiscal management - Social protection initiatives

Gender Equity and Mainstreaming No gender elements
Description 1. The proposed knowledge and support technical assistance (TA) will develop policy recommendations for the People's Republic of China (PRC) to reform its personal income tax (PIT) and social security contribution (SSC) systems and provide training and capacity building for implementing these reforms. The TA request is part of a broader initiative by the government to adjust the tax system to bring it in line with the economic and social development status of the PRC. The TA will explore options to reform the system of PIT and SSC drawing on the experience and good practice in selected Organization for Economic Cooperation and Development (OECD) countries. Specifically, the TA aims to reform the PIT and SSC system with to (i) increase the contribution of PIT to tax revenue, and (ii) address distortions in the PIT and SSC system, notably those that affect the progressivity of the system and give rise to labor market segmentation. The TA is included in the country operations business plan (COBP) 2017 2019 for the PRC
Project Rationale and Linkage to Country/Regional Strategy

Since its reform and opening-up policy started in 1978, the PRC has been devoted to establishing an efficient, stable, and sustainable fiscal and taxation system. During 1996-2014, the growth of tax revenues exceeded nominal gross domestic product (GDP) growth, with the result that the tax ratio rose from 9.6% of GDP to 18.6% of GDP. However, as the PRC's economic and social development has entered a new normal since 2014 and progress is being made with supply-side structural reforms, this trend has reversed and the tax ratio has fallen back to 17.5% of GDP in 2016, which is significantly below the OECD average (25.1% of GDP). Meanwhile, with fiscal expenditure needs continuing to rise, fiscal surpluses have turned into growing deficits, raising concerns about fiscal sustainability.

One of the most important reasons for the decline in the tax ratio is that direct taxes make a relatively small contribution to tax revenue collections. As a result, the PRC's current tax system still relies heavily on indirect taxes on goods and services, whose growth has slowed significantly in recent years following reforms of the value-added tax (VAT) that were geared towards lowering the tax burden on enterprises. The current tax structure in PRC contrasts with international experience that suggests that with increasing income levels, countries tend to move away from indirect taxes towards direct taxation of income and property. Direct taxes in PRC, such as PIT, corporate income tax, account for a relatively small fraction of tax revenue (33.5% in 2014), much lower than the OECD average (59.0% in 2014). There is thus a great potential to maintain fiscal sustainability in the PRC through increasing the share of direct taxes in total tax revenue.

The redistributive effect of taxes and transfers is still relatively limited in PRC. Income inequality, measured by the Gini coefficient announced by the National Bureau of Statistics, was low in the mid-1980s at below 0.3 but has continued to rise to near 0.5 over recent years. Fiscal policy appears to contribute relatively little to narrow the rising inequality, as reflected in the difference between Gini coefficients before and after taxes and transfers. One area that the TA will explore is how reforms to the PIT and social security system might contribute more positively to reducing income inequality, by making the tax system more progressive and by reducing inefficient distortions.

A preliminary review of the literature suggests that the base for collecting PIT in PRC is very narrow and the effective rate for SSC is regressive. The tax schedule for personal incomes is broadly progressive and comparable to those of OECD economies. However, a number of factors reduce this progressivity in practice. First, the highest marginal tax rate for personal income (45%) only starts at the very top of the income distribution (about 35 times the national average wage) and consequently applies to few income earners. In contrast, the top marginal tax rates in OECD countries are imposed at around four times the national average wage. Second, the PIT has a relatively high basic allowance (CNY 42,000 or twice the average national wage). In comparison, the average basic personal allowance in OECD countries is about one-quarter of the average national wage. As a result, less than 20% of workers are liable to pay PIT and the share of PIT payers in PRC is only 3% of the total population in 2016.

Employers and employees are obliged to contribute to social security by making payments into the pension, medical insurance, and unemployment insurance systems. Contributions are withheld from wages and remitted directly by employers. Contribution rates are, on average, about 11% of gross wage for employees, with the exact percentages varying between provinces and localities. Although a nominal flat rate is applied, the rate is levied on a minimum employee contribution based on an imputed value of earnings. The imputed minimum earnings for workers in turn are set at 60% of the previous year's average wage of the locality. It is estimated that around 30% of the urban labor force earns below the 60% threshold in several large cities. This feature of the social security contribution schedule along with the contribution cap set at three times the local average wage implies that the effective contribution rate is very regressive in employee income. This is not only detrimental to income equality but also leads to labor market segmentation.

The proposed TA intends to use Asian Development Bank (ADB) support to explore reforms to the personal income tax and social security system that will contribute to enhancing fiscal sustainability and improving income equality. In addition to assessing the current status of the reforms to the PIT and social security system, the TA will provide a series of case studies that examine the experience and lessons learned in tackling the challenge of mobilizing revenues from PIT and designing an integrated tax and social security system in various OECD countries. These will support the TA's analysis of how to reform PIT and SSC system in the PRC to ensure adequate progressivity and avoid inefficient distortions.

Impact Sustainability of taxation system and equitable income distribution enhanced
Project Outcome
Description of Outcome Contribution of personal income tax to tax revenue increased and distortions in personal income tax and social security contribution system reduced
Progress Toward Outcome
Implementation Progress
Description of Project Outputs

Research studies on personal income tax and social security reforms produced

Capacity in designing new personal income tax and social security system improved

Status of Implementation Progress (Outputs, Activities, and Issues)
Geographical Location Nation-wide
Summary of Environmental and Social Aspects
Environmental Aspects
Involuntary Resettlement
Indigenous Peoples
Stakeholder Communication, Participation, and Consultation
During Project Design
During Project Implementation
Business Opportunities
Consulting Services

Team Leader, Senior National Fiscal and Taxation Expert (Case Study 1)

International Expert on PIT

International Expert on Social Security Contributions

National Fiscal and Taxation Expert (Case Study 2)

National Fiscal and Taxation Expert (Case Study 3)

National Fiscal and Taxation Expert (Case Study 4)

National Fiscal and Taxation Expert (Case Study 5)

National Fiscal and Taxation Expert (Case Study 6)

Responsible ADB Officer Zhuang, Jian
Responsible ADB Department East Asia Department
Responsible ADB Division PRC Resident Mission
Executing Agencies
Ministry of Finance
Sanlihe, Xicheng District
Beijing,100820
People's Republic of China
Timetable
Concept Clearance 01 Aug 2017
Fact Finding 24 Aug 2017 to 25 Aug 2017
MRM -
Approval 23 Oct 2017
Last Review Mission -
Last PDS Update 25 Oct 2017

TA 9405-PRC

Milestones
Approval Signing Date Effectivity Date Closing
Original Revised Actual
23 Oct 2017 - - 30 Apr 2019 - -
Financing Plan/TA Utilization Cumulative Disbursements
ADB Cofinancing Counterpart Total Date Amount
Gov Beneficiaries Project Sponsor Others
300,000.00 0.00 0.00 0.00 0.00 0.00 300,000.00 23 Oct 2017 0.00

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