China is paving the way for another round of tax reforms to improve the fiscal health of local governments. It plans to share the revenue from excise taxes among the central and local governments, and shift the collection from the production end to the retail end, the State Council revealed in a recent media briefing.
Tax reform has been a major policy issue in China for quite some time. However, over the past few years, the focus has been on proposed amendments to specific kinds of taxes such as value-added tax (VAT) and individual income tax. Efforts towards system-level tax reforms and changes to tax sharing and expenditure management among different levels of government have not been as quick as expected.
The slowdown in China’s economy, particularly the hardships facing the real estate market, has triggered the move to speed up tax reforms. Local governments are losing a big chunk of revenue from land sales, increasing the pressure on their fiscal sustainability and making tax reform an even more urgent issue. Understandably, tax reform was a key resolution in the recently concluded Third Plenum of the Chinese Communist Party’s Central Committee.
In the press meeting, Dongwei Wang, deputy minister of the Ministry of Finance (MoF), identified three directions for the next tax reform. These are expanding tax revenue sources for local governments, allowing more autonomy for local governments in managing their tax revenues, and improving local governments’ administration of non-tax incomes.
One type of tax highlighted in the press meeting is the excise tax, which applies to cigarettes, alcoholic drinks, petroleum, jewellery, and other luxury goods. “We are considering moving the collection of excise tax from the production end to the retail end, and will, step by step, make excise tax revenue shareable among the central government and local governments to expand local governments’ funding sources and improve the local consumption environment,” says Wang.
Data from MoF shows that excise tax amounting to 1.61 trillion yuan (US$223.54 billion) was levied in 2023, accounting for about 8.8% of the national tax revenue of 18.1 trillion yuan in the same year and making it the third largest tax in China after VAT and corporate tax. Of these top three taxes, excise tax is the only tax whose revenue is 100% levied by the central government and not shared by local governments.
“Making excise tax revenue shareable among central government and local governments to expand local governments’ funding sources” enables the local governments to acquire a new source of revenue.
Wider tax base
This makes perfect sense, but what is more interesting is “moving the collection of excise tax from the production end to the retail end”. The direct impact of such a measure is to increase the tax revenue by broadening the tax base.
This is so because the value of goods (the tax base) will increase as the goods move along the supply chain. A product that is worth, say, 100 yuan at the production level will sell for 500 yuan when it reaches the retail shelf. If the tax rate remains the same, collecting the tax from the retailer will bring in more revenue.
Additionally, such an arrangement will improve the distribution of tax revenue among local governments since the production of goods is often concentrated in a particular place while sales of the same goods are spread across different places. Municipalities that consume more of the goods that are subject to excise tax will benefit more.
Moreover, municipalities are likely to compete with each other for a bigger share of the excise tax revenue by stimulating the consumption of these goods within their administration. By doing so, they are incentivized to improve the local consumption experience and “improve the local consumption environment”.
This is likely to have a massive impact on the economy as improving domestic consumption is widely regarded as the key to accelerating growth, given that exports, once the engine of the country’s breakneck economic expansion, are facing geopolitical and supply-chain headwinds.
While suggesting that the new tax reform is on the policy agenda, the MoF has not specified a timeline for its implementation. Some observers believe that it may be hard to proceed with the plan at the moment in an environment of weak consumption and deflationary pressure.
Nonetheless, the growth potential for excise tax is strong. According to the MoF, excise tax collection increased by 6.8% year-on-year to 883 billion yuan in the first half of 2024. Many other taxes, such as VAT, corporate tax, income tax, customs duties, and stamp duties, recorded decreases.
