Dhruv Aggarwal analyzes the social ramifications of China’s tax revolution

In 2011, the National People’s Congress (NPC) Standing Committee, responding to public opinion, raised the monthly income tax exemption threshold, the minimum level of income above which a person must pay income tax, from 2000 to 3500 RMB. The exemption threshold was 800 RMB a month in 1980.

The fact that while the tax exemption threshold has increased by over 300 percent, the income of the average Chinese person has shot up by a staggering 2700 percent over the same period is the truly remarkable phenomenon at the heart of China’s tax revolution. Many commentators have emphasized that increases in exemption limits indicate the Chinese government’s responsiveness to popular dissatisfaction with taxation. This view, however, ignores the fact that, with rapidly rising average incomes, more and more Chinese people fall into taxable categories. This flooding of the middle class has offset the increase in the tax exemption threshold.

The rise in general prosperity is no doubt a largely urban phenomenon. Most rural households are exempt from income tax, since their family members are agriculturalists. The rise in per capita income is also starker in the urban sector. McKinsey and Company predicted in 2013 that 75% of Chinese urban consumers would earn between 60 and 229 thousand yuan by 2022. In 2000, this number stood at 4%.

For this high-powered, mostly young demographic, a yearly income tax exemption level of 42,000 yuan is unlikely to mean much. The concentration of taxpayers in urban areas also allows the Communist party to focus on retaining its grip on power – with most rural inhabitants exempt, and urban consumers seeing an exponential rise in incomes, no section of the population could conceivably have major grievances against taxation.

All is not as it seems, however, with China’s taxation system. First, the collection and valuation of taxes itself is questionable. As with all data collected in China, the level and growth of income in the top tier of urban society is contested. Thomas Piketty, the French economist and author of Capital in the 21st Century, has written about China’s tax structure in comparison to that of other developing countries. According to him, the Chinese government needs to be more transparent in the way it releases its tax data. “In particular,” says Piketty, “the government should publish annual income tax statistics by income bracket and by region.”

Piketty’s reference to region is worth noting. Particularly prosperous urban regions, which are mostly found the east of the country, are home to increasingly affluent young taxpayers. Yet while these people are the new backbone of the country’s tax system, they also happen to be considered the greatest potential threat to one-party rule. With higher incomes translating to higher tax sums under China’s progressive tax system, these urban youngsters may start demanding more from the authorities than just ceaseless economic growth.

Throughout history, authoritarian regimes have faced their greatest tests in cosmopolitan metropolises, with their educated and wealthy young populations the most likely challengers to governmental authority. The protests of Tiananmen and the recent upheaval in Hong Kong suggest that the concentration of dissent can often be in the country’s most wealthiest cities and among its most aspirational youth. This “paradox of plenty” may be something that Chinese policymakers and tax authorities need to consider in the future.

The fact still remains that China has seen its income tax revenues skyrocket, accounting for 0.1% of GDP in 1986 and 2.5% in 2008. By 2015, this number is expected to further swell to 10% of China’s GDP. The country’s generous exemption limits have been offset by the wealth advancement of its citizens. By resisting the tendency displayed by other Asian countries like India to keep expanding its classes of “exempt” incomes, China has steadfastly increased its tax-to-GDP ratio. As it continues its transition from being a purely manufacturing-based economy to a consumption-based economy, China would do well to ensure that its tax code stays in touch with the changing socioeconomic profile of its citizenry.

Dhruv Aggarwal is a junior at Yale University and an associate editor of the magazine. Contact him at dhruv.aggarwal@yale.edu.
This article appears in the November 2014 issue of China Hands.