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The primary factor that explains the stagnant revenue contribution of the Chinese PIT since 2006 is the changing amount of monthly wage income that is exempt from the tax. In taxing wage income, the Chinese PIT imposes a progressive rate structure on monthly wage income above an exemption threshold. Between 1994 and 2006, this threshold was set at CNY 800. As urban wage income grew, more and more employees began to be subject to PIT withholding. Even so, the average PIT rate on wage income faced by urban households only increased from 1.1% to 3.1% from 1997 to 2005. In comparison, the general VAT rate was 17% throughout this period and most consumer services were subject to the Business Tax at 5%. Taxes on consumer expenditures thus bore much, much more heavily on the purchasing power of Chinese taxpayers than the PIT.

Nonetheless, the National People’s Congress (NPC) raised the PIT exemption threshold for wages to CNY 1,600 in 2006, and just 1 year later, to CNY 2,000. The result was that the lowest six deciles of wage earners in urban China paid nearly no PIT in 2008. Zhan et al 2019 showed that in 2007, the median individual wage income in an urban household lay below the CNY 19,200 amount that corresponded to the CNY 1,600 monthly exemption applicable that year. Xu et al 2013 calculates that in 2008, the lowest 6 deciles of urban earners of income contributed 5.4% of total PIT revenue—as compared with 4.4% in 1997 and 11.5% in 2005. Their calculation includes PIT revenue on all sources of income (e.g., sole proprietor business income, interests, etc.) and not just wages, and suggests that all of the PIT revenue gains from increasing urban wages before 2008 were wiped out by the lifting of the exemption threshold that year to CNY 2,000.

Notably, because the urban population was only 45% of China’s total population in 2007 but by far the richer, urban households already represented the richer half of Chinese people. Any further increase of the monthly exemption threshold would only benefit the richest 18% of Chinese individuals.

But that was exactly what the government chose to do. In 2011, Premier Wen Jiabao requested the NPC to raise the monthly exemption amount to CNY 3,500: within just 5 years, the exemption level increased by 337%. The Ministry of Finance estimated at the time that this reduced the number of PIT taxpayers from 28% of urban wage earners to 12%. (Using the urban household survey, Zhan et al 2019 confirmed that even in 2013, the median wage income was clearly below CNY 42,000—the annual amount exempted under the 2011 PIT change.) Moreover, the 2011 PIT change broadened rate brackets, such that even in 2013, less than 3% of urban wage earners faced marginal tax rates higher than 20%, and a vanishing portion faced marginal rates higher than 25%.

The 2011 legislative change to the PIT was devastating to PIT administration in China. Many cities lost almost all of their PIT revenue from wages. One city where I recently conducted research ranked in the top third decile of Chinese cities in per capita GDP terms in 2017 (its GDP per capita level was 117% of China’s national average). In that year, 86.1% out of all returns filed by wage withholding agents (i.e., employers) reported zero PIT remittable. In terms of individual wage earners reported on these withholding returns, only 36.4% had a positive PIT liability. This was after urban average wages increased 80% from 2011 to 2017! Because the PIT generates so little revenue, most local tax agencies cannot afford to invest in auditing individual taxpayers and compiling databases about them. Therefore, even the government itself has little information about individuals’ income.

In 2018, the Chinese government took this information-destroying tax policy further, and raised the monthly exemption again to CNY 5,000, corresponding to an annual amount of CNY 60,000. Only two provincial jurisdictions, Beijing and Shanghai, had average individual income above that level in that year. The 2018 PIT legislation also moved further up the rate brackets, so that one needed to earn CNY 204,000 a year (USD 32,380) to face even a 20% marginal tax rate. Moreover, on top of the generous exemptions and wide rate brackets, the 2018 PIT legislation introduced “additional special deductions” for high-income households, such as the mortgage interest expense and children’s education deductions. This means that rich Chinese families can send children to study abroad and claim a PIT deduction for a portion of the expense. Researchers have calculated that these special deductions may further remove 5% of the urban wage-earning population from the PIT tax base.

The government’s repeated undercutting of the PIT since 2006 went against the preferences of bureaucrats in the Ministry of Finance and the State Administration of Taxation. How the rich in China has been so successful in persuading the decisionmakers in China’s State Council to enact the tax cuts is a puzzle. (Most scholars of public finance in China either offered faint praise for the tax cuts or remained silent, perhaps to avoid public derision for asserting that the PIT should remain higher.) One might speculate that two factors are likely relevant.

First, the regions that benefit most from the tax cuts are the rich cities hosting the highest wage earners—Shenzhen, Shanghai, Beijing, etc. These cities have engaged in tax competition for many years by handing (borderline-illegal) PIT tax breaks to bankers and entrepreneurs. They have also continuously sponsored a media mis-information campaign claiming that the low PIT rates in Hong Kong and Singapore are the international norm, and that China needs to cut its top marginal tax rates to be “internationally competitive.” One might thus conjecture that the State Council has been particularly influenced by these regions in making tax policy. Second, the Chinese government has tolerated public attacks on the PIT, as though complaints about taxation represent one subject where public dissent is permitted. The PIT thus appears to be a preferred way for China’s political leadership to cut deals with the country’s economic elite.

Unsurprisingly, Chinese media, also run by elites who might mistakenly believe they are poor, have widely platformed their well-intentioned but misinformed, regressive views in outlets like Southern Weekly and Guancha.

This time, the taxman defended against further cuts yesterday, publishing a rebuttal from Renmin University of China professor Yue Ximing on its front page.

It’s very straightforward: the genuinely poor Chinese wage earners cannot possibly benefit from further cuts of the PIT since they already don’t have to pay PIT. And these little guys don’t have discourse power against the tax cuts for the rich.

As you will read in the following translation, only 30% of wage earners pay PIT, which, by definition, means they are in the top 30% of the country in terms of regular income.

Among them, less than 40% pay a PIT rate above 3%. In other words, any further cuts to PIT, including increasing exemptions, will only benefit the top 12% of wage earners in the Communist Party-governed socialist country.