Personal Income Tax Reform in China in 2018 and Its Impact on Income Distribution

• Author: Xiaojing Xu,Peng Zhan,Shi Li
• DOI: http://doi.org/10.1111/cwe.12279
• Published date: 01 May 2019
• Date: 01 May 2019

China & World Economy / 25–48, Vol. 27, No. 3, 2019

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©2019 Institute of World Economics and Politics, Chinese Academy of Social Sciences

*Peng Zhan, Assistant Professor, School of Economics, Nanjing University of Finance & Economics. Email:

zhanp@nufe.edu.cn; Shi Li (corresponding author), Professor, China Institute for Income Distribution, Beijing

Normal University, China. Email: lishi@bnu.edu.cn; Xiaojing Xu, Postgraduate Student, China Institute

for Income Distribution, Beijing Normal University, China. Email: xuxiaojing1995@mail.bnu.edu.cn. This

paper is supported by the Fundamental Research Funds for the Central Universities (No. 2015KJJCA17), and

Jiangsu Social Science Fund Youth Project (No. 17EYC006). We are very grateful for comments from Jinjing

Li, Xiangyu Wan, Haiyuan Wan, Jun Chen and two anonymous referees.

Personal Income Tax Reform in China in 2018

and Its Impact on Income Distribution

Peng Zhan, Shi Li, Xiaojing Xu*

Abstract

In the context of personal income tax (PIT) reform in China in 2018, this paper

examines some of the major issues of concern regarding the reform and income

distribution. Using the China Personal Income Tax Micro-simulation model, the

paper compares the differences between the 2011 and 2018 PIT systems, and finds

that residents relying on different income sources may face a large degree of real tax

rate change. Once the tax system is altered to PIT 2018, the coverage of PIT for wage

earners will decrease from 46.9 to 23.4 percent, the income redistributive effect will

drop from 1.95 to 1.22 percent and the PIT’s role in scal revenue will also be negatively

affected. Nevertheless, if individual income continues to grow, the share of PIT in scal

revenue is expected to return to the 2018 level in 2022, but its income redistribution

function is difcult to recover in the short term. The paper nds that the effect of PIT

on income distribution depends on the tax structure. Gradual transition to an “entirely

comprehensive” tax system when conditions are appropriate will achieve better income

redistribution results at a lower average tax rate.

Key words: micro-simulation, personal income tax reform, residential income distribution

JEL codes: C63, D31

I. Introduction

China’s personal income tax (PIT) law was first adopted at the Third Session of the

Fifth National People’s Congress (NPC) in 1980. Six amendments have been made, in

1993, 1999, 2005, 2007 (twice), and 2011. On 19 June 2018, in the Third Session of

the 13th NPC Standing Committee, the Ministry of Finance proposed a review of the

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©2019 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Amendment of the Personal Income Tax Law of the People’s Republic of China. On 31

August 2018, the Fifth Session of the 13th NPC Standing Committee passed the motion

to amend the PIT law, completing the seventh major overhaul. Because PIT is directly

linked to residents’ income, each round of PIT reform can stir up public opinion. From a

taxpayers’ perspective, almost everyone expects to pay as little tax as possible. However,

as an important tax for most countries in the world, PIT serves practical functions.

Thus, the crux of PIT reform lies not in reducing the tax burden of all people, but in

generating scal revenue and redistributing income more fairly among residents.

When PIT was rst created in Britain it played the full role of scal revenue source

to cope with the large military expenditure required during the war between Britain and

France (Lubbock, 1894). During World War I (WWI), PIT rates in Europe and the US

increased sharply in response to substantial scal expenditure. They decreased slightly

after WWI but rose sharply again when World War II began (Piketty, 2014).

With the expansion of income and wealth inequality, increasing attention has been

paid to the income redistribution function of PIT. In 1870, the wealth of the richest 1

percent of the population in the US accounted for 27.9 percent of the total wealth of

society. It rose to 41.9 percent in 1916 (Rosenbloom and Stutes, 2004). During this

period, many countries began to consider the exemption amount and progressive tax rate

structure in PIT, with the aim of reducing the actual tax rates of low-income groups and

increasing those of high-income groups (Xia, 2013). In the 1950s, the highest marginal

tax rate targeting high-income groups in the UK and the US even reached 90 percent

(Piketty, 2014).

China’s PIT accounts for a relatively low share of the government tax revenue,

registering merely 8.3 percent in 2017 according to the 2018 China Taxation Yearbook.

PIT is unlikely to become the main share of government revenue in the short term.

However, value-added, business and consumption taxes, which account for a higher

share of tax revenue, potentially increase income inequality, with the tax burden of

low-income families higher than that of high-income families (Yue et al., 2014). At

present, China does not have a property tax based on the stock of real estate, nor does

it implement an inheritance tax. Only PIT functions to narrow the income inequality

among all taxes (Yue et al., 2014), making its income distribution function particularly

important. The problem faced by China is how to reform PIT so that it more effectively

redistributes income while maintaining the scale of tax revenue.

This paper discusses the impact of PIT reform on residential income distribution.

PIT reform includes several key elements: classied tax system or comprehensive tax

system; taxes paid by individuals or by families; the amount of exemption and the

structure of tax rates of specic income tax; special deductions for special cases; and