On 15 August 2017 the IMF issued a report and selected issues paper following consultations with China under Article IV of the IMF’s articles of agreement.

The report notes that China is continuing its transition to more sustainable growth with 6.7% growth in 2016 and the same level projected for 2017. Progress has been made in rebalancing the economy towards services and consumption. The firmer economic activity gives an opportunity to accelerate reforms in areas such as greater social spending; further reforms of state owned enterprises; and reduction of financial stability risk through further efforts on regulation and supervision. The report suggests that further improvements in policy frameworks are required to maintain medium term growth and stability and local government autonomy could be increased.

Central-local fiscal relations

The selected issues paper notes that China has the largest share of local government spending in the world, but there is limited revenue autonomy at the local level. The paper notes that decentralization of revenues permits a more satisfactory matching of the tax system to the local situation and preferences, as well as encouraging accountability of policy makers. However centralization of taxation has benefits in terms of economies of scale, risk-sharing, and dealing with the mobility of the tax base.

The paper suggests that the provinces could be permitted to impose a surcharge in addition to the national personal income tax (PIT). This would allow the provinces some tax autonomy within a limit specified by the centre, for example an upper limit of 5% or 10%. The revenue contribution of the PIT is currently low by international standards and this would also be a way of increasing that contribution.

In the case of value added tax (VAT) there would be difficulties in implementing any VAT at the provincial level owing to the difficulties in monitoring border flows between local jurisdictions. The national scope of the VAT should therefore be maintained but there could be a review of the revenue-sharing arrangements to reduce compliance costs for taxpayers with multiple business locations. This could be done by introducing simple allocation rules based on factors like population or aggregate consumption.

The paper considers that a recurrent market-value based property tax would be suitable for local governments in China. A property tax would be linked to public service delivery through property values and as it is based on property its base is immobile. The accountability of local officials is helped by the fact that the tax is visible to local residents on a recurring basis. High-income households also generally have higher property wealth and a local property tax could therefore be regarded as progressive. Local governments could set tax rates within bands set by the central government, applicable to a tax base that is defined according to national guidelines.

Reducing inequality

There is increasing income and wealth inequality in China but tax reforms could be used to increase inclusiveness. If the tax system could be restructured to rely more on personal income tax this could also improve redistribution, as the income tax can easily be given a progressive structure. The current personal allowance could be lowered and transformed into a tax credit. Tax brackets could be redesigned to ensure that those with greater ability to pay are contributing more to the national budget. The method of imputed minimum earnings for calculating social security contributions is regressive and should be abolished so that direct taxes would be more equitable and workers could have more incentive to join the formal sector.