As China seeks public feedback on the implementation of its recently passed value-added tax (VAT) law, a group of economists has urged the government to introduce more radical reforms to give local authorities stronger incentives to spur consumption and rein in their excessive industrial expansion.
The new VAT law, which is due to come into force next year, introduces a range of technical changes to the tax code that bring China more into line with international practices, but the economists argue that a bolder overhaul of the system could be key to helping the country rebalance its economy.
China’s current VAT system – the country’s largest source of tax revenue – undermines Beijing’s efforts to develop a more consumption-driven economy by creating an incentive structure that dampens officials’ “enthusiasm for fostering consumer markets”, the economists said in an article published in early August.
The main issue with the system is that it allocates tax revenue to regions based on where a product or service was produced, rather than where it was consumed, according to the paper co-authored by Sheng Songcheng, a former head of statistics at China’s central bank, and two researchers at the CEIBS Lujiazui International Institute of Finance.
The policy effectively rewards regions with large industrial bases, which encourages officials to pursue “a local development model that overemphasises investment while neglecting consumption, exacerbating overcapacity and hindering economic transformation and upgrading”, the authors said.
While the system was effective in supporting local government finances during an earlier period in China’s development, “its drawbacks have become increasingly apparent as consumption gradually emerges as the main growth driver”, they added in the article posted online by the China Chief Economist Forum think tank.
To fix the problem, the economists called for a revamp of the current allocation system to ensure that more tax revenue is directed to locations where consumption occurs.