Tax Effort in China

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Tax Effort in China

• Jane H. Leuthold
• University of Illinois at Urbana-Champaign

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Topics

• Why study tax effort?
• Tax effort defined
• Estimation models and data
• Results of estimations
• Implications for Chinas tax system

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Why study tax effort?

• Tax effort studies typically compare actual tax
  share with predicted tax share.
• Used for for judging the potential of taxation
  for funding public spending increases.
• Also used by international lending agencies as a
  basis for allocating international grants.

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Purposes of study

• To assess the level of tax effort in China by
  comparing the tax effort of a sample of
  middle-income countries using World Development
  Indicator data for 1998.
• To examine the changing level of tax effort in
  China during the 1990s using a panel of Southeast
  Asian countries.

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Tax effort defined

• Tax effort is the exertion a country puts into
  collecting its tax revenue, given the tax handles
  available to the country.
• A tax handle is an easily accessible tax base
  that yields a productive revenue source.

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Tax Effort Index (TEI)
TEI actual tax share / predicted tax share If
TEI gt 1, country displays high tax effort and
conversely if TEI lt 1.
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Earlier studies of tax effort

• Tait, Grätz, and Eichengreen (1979)
• Cross-country data
• Leuthold (1999)
• Panel data

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Methodology
SHARE f(A) where SHARE central government
tax revenue as a of gross domestic product
(GDP) and A a vector of tax handles.
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Tax handles

• Per capita GDP in constant 1995 US
• Agriculture value added as a percent of GDP
• International trade as a percent of GDP
• Population growth rate

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Cross-country sample

• World Development Indicators 1998
• 40 middle-income countries

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Cross-country estimation model
SHAREi ?1 ?1GDPperCAPi ?2 AGi
?3 TRADEi ?4 POPi ei Expectations ?1
and ?3 gt 0 ?2 and ?4 lt 0
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Panel model
(2)  SHAREit ?1 ?1GDPperCAPit ?2 TRADEit
?3 POPit ?2 Z2t ?3 Z3t
?N ZNt ?2 Wi2 ?3 Wi3
?T WiT eit where Zit 1 for the ith
cross-sectional unit (country), 0
otherwise (i 2,3, , N) Wit 1 for the tth
time period, 0 otherwise (t 2,3, ,
T)
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Panel sample

• World Development Indicators 1990-1997
• Six Southeast Asian countries (China, Indonesia,
  Korea, Malaysia, Philippines, and Thailand)

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Cross country results
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Cross country TEIs
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Panel results
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Panel TEIs
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Explanations

• Fiscal decentralization
• Short tax history
• Country size
• Corruption

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Measuring corruption level

• Used the 2001 Corruption Perception Index (CPI)
  calculated by the Internet Center for Corruption
  Research, which is a joint initiative of
  Goettingen University and Transparency
  International
• Corruption level 10 CPI
• 61 countries

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Corruption
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1994 Chinese tax reform

• The top marginal enterprise income tax rate was
  reduced from 55 to 33 and the separate tax
  schedule for state and non-state enterprises was
  abolished.
• Reduced the multiplicity of VAT tax rates to two,
  a basic rate of 17 and a lower rate of 13
  applied to foodstuffs and agricultural inputs
• Extended the VAT to cover the wholesale and
  retail stages, as well as the previously covered
  manufacturing stage

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WTO accession

• Transform VAT from an income-type to a
  consumption-type VAT
• Integrate the enterprise income tax on domestic
  and foreign businesses
• Lower customs duties

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Demand for higher tax shares

• Demand for social services (health care,
  education, income support)
• Social Security

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Summary

• The main finding of the study was that while tax
  effort in China is low compared with other
  middle-income countries, tax effort in China is
  increasing, particularly since the tax reform of
  1994.
• How can China increase its tax effort?

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Sources of increased tax effort

• Broadening existing tax bases
• Balancing central and subnational government
  funding responsibilities and tax revenue
• Better collecting taxes
• Adding new taxes

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Thank you

• Questions and comments very welcome
• Paper draft is available online at Tax
  Effort in China