The economies around the world have been affected to varying degrees since the outbreak of the COVID-19 pandemic. Bucking the trend, China achieved decade-high economic growth of 8.1% in 2021 amidst the pandemic. Such an achievement showed that China’s macro economy had mostly adapted itself to the impact of COVID-19 and realized steady improvement in quantity and quality, but it is important to notice the new downward pressure on the growth of China’s economy after achieving the optimistic economic data.

The Central Economic Work Conference held from December 8 to 10, 2021 pointed out that China’s economic development is facing pressure from demand contraction, supply shocks, and weakening expectations.

Factors including tense geopolitical situation, COVID-19’s ongoing impact on the world, and complex world political situation have caused enormous uncertainty in external demand that occupies an important position in China’s economy and plays an important driver of China’s economic growth since the outbreak of the COVID-19 pandemic. China’s trade surplus in goods reached USD 526.9 billion in 2020, up USD 105.9 billion compared to 2019 before COVID-19, and reached USD 676.43 billion in 2021. However, in contrast to the rapidly-expanding trade surplus, the domestic demand grows slowly.

Furthermore, against the background of the global division of labor, China’s industrial chains face problems including shortages of raw materials and spare parts as affected by COVID-19 overseas, leading to insufficient supply and product price increases.

Finally, the high growth in 2021 was because of the relatively low base of the previous year. The growth rate will continue to shrink compared to the same base as China’s economic volume continues to grow. It may be difficult to avoid a decline in GDP growth in the future.

The Central Economic Work Conference required that in 2022, we must make economic stability our top priority and pursue progress while ensuring stability; all localities and government departments should fulfill their responsibilities for maintaining stable macroeconomic performance by proactively introducing pro-stability policies.

To achieve this goal, it is important to actively bring into play the role of finance in increasing expenditures and providing policy support for stabilizing the economy and also extensively increasing revenue and supporting the implementation of fiscal policies.

Increasing expenditures: Finance needs to play an active role in stabilizing the economy

The synergy between COVID-19 response policies and economic policies is required for stabilizing the economy hit by COVID-19. To ensure stability on six key fronts (employment, financial operations, foreign trade, foreign investment, domestic investment, and expectations) and maintain security in six key areas (job, basic living needs, operations of market entities, food and energy security, stable industrial and supply chains, and the normal functioning of primary-level governments), the first prerequisite is to prevent the COVID-19 pandemic from wreaking havoc. It will be very difficult to achieve the goal of stabilizing the economy if COVID-19 is not effectively controlled. After COVID-19 is effectively controlled, how to eliminate the “complications” and “sequelae” to the economy caused by COVID-19 and how to expand domestic demand and ensure supply rely on the economic policies. However, both COVID-19 response policies and economic policies cannot be separated from financial support.

According to the data from the National Bureau of Statistics, the growth of state expenditures on medical treatment and healthcare reached 8.1%, 6.7%, and 15.3%, respectively from 2018 to 2020, with the growth in 2020, where the COVID-19 pandemic was the most serious, more than double that before the pandemic. Important reasons for the increase in expenditures on medical treatment and healthcare included the expenditure on concentrated nucleic acid testing, treatment costs for COVID-19 patients, and salaries of COVID-19 response personnel. Sporadic outbreaks have occurred in various places since the beginning of 2022, and the expenditure on COVID-19 response still relies on financial support.

Under pressure on both supply and demand, the government has launched various economic policies to boost consumption and ensure supply. On the demand side, local governments issue consumption vouchers to stimulate consumption and unleash consumption demand through subsidies; to further unleash consumption demand in rural areas, local governments successively launch policies to promote spending on automobiles, home appliances, furniture, etc. also through subsidies. On the supply side, more easing monetary measures promote business investment, and a series of tax and fee reductions mitigate the burden on enterprises.

The goal of stabilizing the economy requires policy support, but the implementation of policies leads to higher fiscal expenditures and lower fiscal revenue. Then, how to realize the balance of revenue and expenditures on the premise of ensuring the full implementation of policies and the successful achievement of the goal? The only way is to increase revenue.

Increasing revenue: Tax revenue is the breakthrough

The sources of fiscal revenue in China mainly include state-owned capital operations, government funds, social insurance funds, and taxes. Among them, government fund revenue is mainly from land revenue. “Land finance” had promoted China’s urbanization, but the dependence on “land finance” today has seriously affected the overall consumption capacity and the development of the related real industries. It has now become a consensus that the “land finance” model that “eats May’s grain in April” is unsustainable, and it is almost impossible to find a new growth point for fiscal revenue therefrom. Social insurance fund revenue is huge, but its expenditure is huger. It is difficult for social insurance funds to balance their own revenue and expenditures, and the country has repeatedly allocated state-owned assets to increase the social insurance funds. It is also difficult to increase the operating revenue of state-owned assets in a short period, which are burdened with the task of supporting the social insurance funds, so it is not realistic to use them as a breakthrough.

In China’s fiscal revenue, taxes, especially individual income tax, account for a relatively small proportion. The United States and China have a similar Gini coefficient, but the proportion of individual income tax in total fiscal revenue is much lower in China than in the United States. Therefore, individual income tax may become a breakthrough for increasing fiscal revenue.

Promoting individual income tax reform is undoubtedly the most effective method, but it involves a wide coverage and a long timeline. Besides reform, individual income tax revenue can be increased from the following aspects in the short term.

1. To strengthen collection and management and crack down on tax evasion

The biggest problem facing individual income tax collection lies in tax evasion. Cases of celebrities and online streamers being punished with sky-high fines for tax evasion have been common in recent years. For example, in 2018, the tax authorities investigated that actress Fan Bingbing and the enterprises with her as the legal person underpaid RMB 248 million in taxes, including RMB 134 million evaded. Thereafter, the State Taxation Administration strengthened tax supervision over the film and TV industry, and celebrities paid taxes owed of about RMB 11.8 billion in the same year. At the end of 2021, the Hangzhou Municipal Tax Service notified that Viya, an online marketing streamer, evaded RMB 643 million in taxes and underpaid RMB 60 million by concealing her personal income and falsely declaring taxes by fabricating business and converting the nature of income from 2019 to 2020. After Viya was fined, thousands of online streamers conducted self-examination and paid taxes owed.

The individual amount of tax evasion by celebrities and internet influencers is large, but the number of people involved is relatively small. On the other hand, the number of enterprises evading taxes by paying salaries in the reimbursement form of cash and transportation and meal expenses is relatively large. Many enterprises break down their employees’ salaries into basic salaries, year-end bonuses, festival bonuses, various subsidies, etc. for distribution, and some ask their employees to find invoices for offsetting every month, to evade salary taxes in the form of reimbursement. Professional finance teams control the reimbursement ratio within a certain range, to avoid attention and inspection of tax bureaus. However, even if the ratio is not high, the amount involved will still be a huge figure over time.

To solve tax evasion, tax collection and management should be strengthened in addition to the improvement of related laws and regulations. In the examples above, the punishment for and notification on a typical case had driven a group of related persons to conduct self-examination and pay taxes owed. The studies of scholars including Tian Binbin and Du Pengcheng found that the weaker the intensity of tax collection and management, the higher the tax evasion level of taxpayers, and tax evasion is less in the regions with strict tax collection and management. This means that China needs to further increase tax collection and management efforts.

2. To participate in international cooperation to improve the level of anti-tax avoidance

Compared with the tax evasion behavior that openly breaks laws or regulations, the more covert overseas tax avoidance behavior is commonly seen among the high-net-worth individuals. Shareholders can exploit the loopholes in laws to minimize corporate income tax and individual income tax by registering companies overseas. There is no evidence or law for investigating such a tax avoidance method due to policy reasons and the high opacity of overseas information. Reality has proved that the loopholes in laws may be huge. The U.S. research institute ProPublica revealed that the true tax rate paid by the 25 richest Americans from 2014 to 2018 was only 3.4%, including 0.98%, 3.27%, and 0.1% paid by Bezos, Musk, and Buffett, respectively, far lower than the U.S. average. Since the rich in the United States, whose tax system is far better developed than China’s tax system, can so avoid taxes, will the situation in China be better?

The good news is that the newly revised Individual Income Tax Law in China has added the “anti-tax avoidance clause”, which will provide a better institutional guarantee and law enforcement basis for tax authorities’ future anti-tax avoidance practice related to individual income tax. However, besides the law to abide by, there shall also be evidence to investigate. The asymmetry and opacity of information have brought great difficulty to the anti-tax avoidance. China, in the cat-and-mouse game of tax avoidance and anti-tax avoidance, should strengthen information exchanges with foreign governments to enable multinationals’ financial information to be transparent and available.

3. To update the regulatory techniques and exert the advantages of big data

Due to limited inspection resources, tax authorities mainly checked tax evasion through random inspection in the past, causing some taxpayers to take a chance on tax evasion. As human capabilities are limited, sci-tech means should be used to completely eradicate the problem of tax evasion and improve the “productivity” of tax inspection authorities.

Tax big data is one excellent representative of the said means. Tax big data refers to a category of big data set formed in the process of tax collection and management, including structured data and unstructured data. In the era of big data, based on tax big data, data mining enables tax authorities to deeply dig up taxpayers’ tax-related information, assess the potential risk of tax evasion, and focus on monitoring taxpayers with a high risk of tax evasion, thereby promoting tax compliance. In the above example of Viya’s tax evasion, her suspicion of tax evasion was discovered through tax big data analysis and assessment. Tax big data has broad application prospects in tax inspection, but in practice, attention should also be paid to the realization of data linkage and the dynamic adjustments to risk identification models.

It should be noted that using individual income tax as a breakthrough for increasing fiscal revenue does not mean increasing the tax burden on the whole people. For example, in the United States, individual income tax revenue is mainly from the middle- and high-income groups, and low-income groups pay little or no income tax. This means that the breakthrough of fiscal revenue lies in individual income tax, and the breakthrough of individual income tax lies in high-income groups. Therefore, using individual income tax as a breakthrough for increasing fiscal revenue will not increase the burden on the general public; instead, it can narrow the domestic income gap, ease social conflicts, and provide financial support for economy-boosting policies.

Source: Yicai, February 28, 2022