Personal income tax reform advances towards a "comprehensive" approach, balancing tax burden differences among various items

Securities Times reporter He Jueyuan, Guo Bohao

Individual income tax (hereinafter referred to as “IIT”) is the tax category most closely related to ordinary people. Optimizing its system concerns not only increasing the proportion of direct taxes, but also serving as an important tool for adjusting the income distribution pattern. The outline of the “Fifteenth Five-Year” plan clearly states that “expanding the scope of comprehensive collection” and “improving the tax policies for income from business operations, income from capital, and income from property” will be listed as directions for IIT reform.

To strengthen the tax’s function of adjusting income, promote fairness in tax burdens, and balance the tax burden differences among various types of income under IIT, this will become a key focus of reform.

Since the IIT reform in 2019, China has adopted a “small-comprehensive, large-classification” taxation model. For four categories of labor income—income from wages and salaries, income from remuneration for labor services, income from author’s remuneration, and income from royalties—comprehensive taxation is applied. For five categories of income—income from business operations, income from the lease of property, income from the transfer of property, income from interest, dividends, and bonuses, and incidental income—classification taxation is still followed. Through institutional arrangements such as comprehensive taxation and special additional deductions, the previous round of IIT reform addressed issues such as imbalance in tax burdens under wholly classification taxation, large tax-avoidance space, and low tax administration efficiency; and the tax burden levels of middle- and low-income groups have been effectively lowered.

At present, China has initially established an IIT system combining comprehensive and classification approaches, but the tax burden differences among different income categories remain obvious—especially between comprehensive income and business income, between labor income and capital income, and between labor income and property income. This is precisely the reform direction specified in the outline of the “Fifteenth Five-Year” plan.

Driving labor income to be taxed uniformly, and bringing business income into the scope of comprehensive collection, has become a general consensus in academia. Under the current IIT system, the four categories of labor income are subject to comprehensive taxation, with a seven-bracket excess progressive tax rate whose top rate is 45%. Business income, which also has labor attributes, is subject to a five-bracket progressive tax rate, with a top marginal tax rate of 35%. In practice, the two sometimes result in “tax burden inversion.”

In addition, the rules for defining business income versus remuneration for labor services are ambiguous, and in recent years this has triggered a series of unlawful arbitrage behaviors—some online streamers have converted live-streaming income, which should be taxed as remuneration for labor services, into business income without authorization, and have used the approved collection method without authorization to pay less tax. This not only causes the loss of national tax revenue, but also undermines fairness in tax burdens.

“By including business income in the scope of comprehensive taxation, it can achieve fair tax burdens for labor income of different types, prevent taxpayers from engaging in tax arbitrage, and is conducive to regulating tax administration for groups such as individual industrial and commercial business owners and investors in sole proprietorship enterprises.” Tian Zhiwei, dean of the Institute of Public Policy and Governance at Shanghai University of Finance and Economics, told Securities Times reporter.

The actual tax burden differences between labor income and capital income/property income are similarly significant. Unlike labor income, which uses the seven-bracket excess progressive tax rate, capital income is uniformly taxed at a proportional tax rate of 20%. In a signed article published in Tax Research, Ma Caichen, a professor at the School of Economics, Nankai University, pointed out that in terms of the taxation model, if labor income is combined for taxation while capital income is taxed separately, it may cause the tax burden on capital income to become decoupled from its income level. People who work diligently and have multiple sources of labor income bear a heavier tax burden, which is not conducive to achieving tax fairness.

In the long run, as some capital and property incomes—such as dividend income and income from the transfer of property—are gradually included in the scope of comprehensive taxation, it will help strengthen the function of tax redistribution. “This move will reduce the tax-avoidance space for high-income groups through capital operations, and the direct impact on middle- and low-income earners will be smaller, thereby enhancing the regulatory role of IIT.” Duan Shiwei, a researcher at the Behavioral Experiments Center for Taxation and Finance at Renmin University of China, told the reporter.

As a major institutional innovation in China’s IIT reform, the IIT special additional deductions system effectively lowers households’ tax burden. The outline of the “Fifteenth Five-Year” plan clearly requires giving full play to the policy role of special additional deductions and increasing the力度 of deductions. Aiming to promote fairness in tax burdens, Tian Zhiwei believes that in the future, the IIT special additional deductions system should precisely match the tax-relief needs of different family structures and income levels.

The tax-reduction effect of special additional deductions is directly linked to the marginal tax rate applicable to the taxpayer. Against the backdrop of increasing deduction力度, there are clear differences in the actual tax burden relief received by different income groups—when the deduction amount is the same, the group subject to a higher marginal tax rate will enjoy more of the tax-relief benefits.

Tian Zhiwei suggests building a special additional deductions model of “a basic standard + a floating standard,” and precisely compensating for people’s livelihood expenditures in different regions and with different family structures in a differentiated manner. In the future, it could be considered to file applications on a household basis, connecting special additional deductions with household income.

Based on international experience, major developed economies such as the United States and Canada use the inflation rate as a reference and dynamically adjust the special additional deductions standards each year. In Duan Shiwei’s view, China’s special additional deductions standards may be referenced against indicators such as per-capita consumption expenditure, the inflation level, and the social average wage, so that the deduction standards can be optimized in line with changes in living costs, thereby more precisely matching different households’ needs for tax-relief.