Remarks by Angel Gurría, OECD Secretary-General, delivered at the China Development Forum
Beijing, Sunday 24 March 2013
Minister Lou, distinguished guests, ladies and gentlemen;
It is both a pleasure and an honour to speak with you again at the China Development Forum (CDF). This forum has certainly grown in size and importance over the past years and I congratulate the Development Research Centre and the Secretary-General of the CDF Foundation for their strong and entrepreneurial vision.
Today’s topic, reforming fiscal and taxation systems to promote inclusive growth, is crucial. Taxes are not only necessary to fund government expenditure, they can also be an effective lever to achieve a fairer distribution of income. At the same time, taxes may distort economic behaviour and risk damaging economic growth. Taxes are thus a delicate area of government policy. Let me begin my discussion today by looking at the strengths of China’s tax system.
A look at China’s tax system: signs of overall health.
Clearly, good tax policy and administration is necessary for China to sustain its economic growth and to make it greener and more inclusive, ensuring that the burden of taxation is fairly distributed. Using tax revenues efficiently has a key role to play in making growth fairer.
But the first challenge of any tax system is to ensure that the state raises sufficient revenues to maintain sound public finances. China has amply succeeded here. Public deficits are low and tax revenues have risen steadily in relation to GDP. If levies and fees are included with taxes, the overall tax burden is now of the order of 29% of GDP. This tax burden is higher than in six of the eight OECD member countries that border the Pacific.
Moreover, in the past five years, the tax burden has been increasing at the pace of three-quarters of a percentage point every year. Another five years and taxation will be approaching the lower end of the tax burdens seen in Europe.
China is also implementing reforms to strengthen its tax system, replacing Business Tax with a Modern VAT. These reforms are important given that indirect taxes currently make up more than 60% of the total tax revenues, substantially more than in OECD countries. Moreover, some of them are particularly distortive, as they cascade from one company to another. While this process may imply revenue losses at first, the rolling out of this reform across China will surely deliver efficiency gains.
Despite its strengths, the tax system’s ability to foster inclusiveness can be improved.
First, there is an urgent need to revise the sharing agreements between the central and local governments. The transition to a modern VAT creates a good opportunity to do so. It has been nearly 20 years since the last reform, and local governments have become overly reliant on transfer payments. Moreover, going forward, the need for such transfers will only increase, in order to: first, ensure that public services are provided equally across provinces; then, to finance local investment in infrastructure required by rapid urbanisation; and last but not least, to finance social spending, mostly made at the local level.
Our 2013 Economic Survey, which I presented yesterday at the Economic Summit, provides a series of recommendations regarding intergovernmental fiscal relations. It calls, inter alia, for raising the share of general intergovernmental transfers and improving the design of earmarked ones. It also recommends switching from taxing land transactions to taxing land possession, while keeping the overall property tax burden broadly unchanged. This would, inter alia, ensure a stable source of revenue over the long term.
Second, there is room for increasing the progressivity of the income taxes. Few people pay income tax, as the exemption threshold is high, and corporate income is taxed separately at a low rate. But the progressivity of income taxes is limited relative to most OECD countries. Indeed, while the highest marginal rate of income taxation is certainly high, at 45%, it only applies to incomes above around 30 times average earnings. Increasing the progressivity of the income tax would also help to increase tax revenues, as income tax currently raises less than 5% of total tax revenue.
Third, increasing environmental taxes would allow increasing revenues, to be used for general policies towards a more inclusive society, while helping curbing pollution, which often affects low-income earners most. A tax on emissions and higher taxes on gasoline would represent positive steps in this regard. A congestion tax in major cities would also help ensure that the externalities of traffic jams are internalised. And recurrent property taxes would increase the incentives for local governments to preserve the environment.
The social security system: an effective tool to foster inclusiveness.
These measures are essential for reducing inequality in China. They complement the general increase in tax revenues, which has made it possible to finance a large part of the social security system, starting with a generalised insurance against health risks. As a result of these measures, China’s social spending has already risen in relation to GDP to the level of OECD countries, such as Chile, Korea and Mexico. This is one of the most remarkable achievements of the past five years.
For sure, there is much room for improvement. Contributions are levied at high rates, leading to evasion, and rates vary across the country. Moreover, it is still difficult to transfer entitlements from one city to another. As for tax administration, it is advisable, at some point, to bring the collection of the income tax and social security under one agency, and even to amalgamate these two to build up a national system. This reduces the costs of collection, compliance and, ultimately, service delivery.
Additional tools to promote more inclusiveness in China.
But there are limits to the use of fiscal policy and tax reform, however smart they are, to generate inclusive growth. They can do much, but not everything. The main source of inequality in China is indeed the difference in earnings between the rural and urban areas, reflecting a fundamental economic reality: the number of people attempting to earn a living from the land is too high for the amount of land that can be farmed productively.
As also documented in our Economic Survey, inclusive urbanisation can thus be a crucial policy tool to tackle inequality. Smart urbanisation will continue to bring enormous economies of scale, which need to be shared broadly. Policies need to prepare people for an urban life in a society that will be dependent increasingly on innovation and technical advances as a source of growth and competitiveness. To ensure that all of China’s people have the opportunity to benefit as the country grows, we recommend two specific policies.
Firstly, migrant children will need better education. It is urgent to end all discrimination in access to education, otherwise inequality will be passed on from generation to generation. This also requires ensuring that cities have adequate resources to fund education for all resident youth, a goal that requires some revisiting of the arrangements for funding services across levels of governments.
Secondly, it is crucial to ensure an adequate supply of land to make housing more affordable, thus allowing more migration to cities, a fundamental way to lower inequality. To achieve this, farmers should be allowed to develop land to house migrant workers, sharing the gains with the government.
Last, but not least, a word on Base Erosion and Profit Shifting. This is the growing issue of tax loopholes that enable corporations to shift profits to more favourable tax jurisdictions and avoid taxes. They constitute a major risk to tax revenues, tax sovereignty and tax fairness, jeopardizing the integrity of the tax system as a whole. Disentangling those loopholes will help all governments, including China, to access untapped sources of revenue, and thus to finance social spending and investment necessary to support more inclusive growth. This is the purpose of the OECD’s work, requested by the G20, on “base erosion and profit shifting”, or BEPS. This issue indeed requires a global coordinated response, and we are leading this work at the OECD, together with China and other G20 countries
Ladies and gentlemen,
The challenges for the next ten years are enormous, at the national and the global level. The fiscal and taxation reforms will be more than ever necessary to ensure that growth becomes more inclusive. So far, China has had a major success in reducing the worst aspect of inequality: poverty. But additional tax reforms will be needed to reduce further inequality in disposable income and across regions, as well as to help reduce the rural-urban divide. Tax is powerful, but not omnipotent!
The OECD stands ready to support the Chinese government in its successful path toward achieving a “moderately prosperous” and more equal society. It is doing so by sharing the experiences of its member and other partner countries. We hope this way to also learn from the Chinese policy experiences and be able, together, to support global efforts to get the world economy not only stronger, but fairer and greener.