Business tax for services. Service industries will face a business tax of 3% to
20% on sales in place of the VAT. This tax also will apply to transfer of
intangible assets and the sale of real estate.[15]
Capital Gains. A capital gains tax was to be introduced in 1994, but its
implementation was postponed because of concern over its adverse impact on
China’s fledgling stock markets.
1996 Reforms
In 1996, China announced plans to reduce its
import tariff rate from 35.9% to 23%, while abolishing preferences for certain
goods and, importantly, eliminating exemptions from import tariffs (currently,
over 80% of imports are exempt from import duties for various reasons). [16]
This step alone should help to reduce the recent losses in customs revenue. The
Ninth Five-Year Plan also includes provisions to introduce taxes on interest
earnings and inheritances, policies designed to reduce income disparity.
Revision of Tax Collection Structure
In order to make the above tax policy changes
effective, the tax collection system must be revamped and greatly improved.
The current structure is based on a system of revenue contracts between
enterprise and government unit, and between local and central governments. One
of the necessary reforms involves tax exemptions, which local governments often
have the authority to grant to enterprises who for one reason or another are
unable to pay their taxes. This is a fundamental weakness in the Chinese
fiscal system: local government has decision-making authority to grant
exemptions on a tax the proceeds of which may in large part be assigned to
governments above. Numerous conflicts of interest can appear to reduce
incentives to enforce the tax at the local level.[17]
To address these changes, China in 1994 initiated
the setting up of a centrally-managed National Tax Service. This would replace
the contract system with a national “tax system,” based on uniform rules of tax
assignment and tax sharing. Certain assignments will be assigned to local
governments, and others to central government; others will be shared according
to predetermined formulas. Interestingly, in 1995, a special police unit was
set up to protect tax collectors under this new program.[18]
A potential obstacle to tax reform comes from
local governments. Local governments have traditionally supported reforms.
But this is because the reforms have usually given them greater autonomy. The
tax system reforms need to restore some control over investment and spending
back to the central government, which could encounter local opposition.
Allowing local governments some discretion over local tax rates can give them
some of the autonomy they desire, and provide greater incentive for
intergovernmental cooperation.
Few reports exist at present on the
implementation of these reforms. Certainly, the spirit and scope of the reforms
has been well-received by analysts, though more changes are advocated. But it
will take several more years to determine the success of the reform of tax
collection structures at the local level.
Intergovernmental Fiscal Relationships
A product of economic reforms in transitional
economies is often a shift in intergovernmental fiscal relationships. In the
transition from centralized economy to market economy it is often from a
relationship where the local or provincial government is the receiver of the “plan”
to the local or provincial government proceeds with a greater autonomy. The
evolution of this relationship in the PRC has been very similar. However, the
provincial or local governments were at an advantage over many other
transitional economies because the Chinese system had the following
characteristics 1)local implementation capacity was already established in the
rural areas 2)China in most areas has a high ethnic homogeneity and 3) there
was much to gain by inter-province trading[19]
The very nature of Chinese economic
reforms, gradual and incremental, allowed “scaffolding” of behavior. Partial
reforms provided the environment to learn behaviors that could then be applied
to the next level of reform. Chinese economic reform was also structured on the
idea of decentralization. The establishment of Special Economic Zones (SEZs)
encouraged the local areas to develop their own strategies to attract business
and allowed them the freedom to implement the strategies. The very earliest
reforms, breaking up of farm communes, were also carried out at the local
level.
Many of the SEZs are doing very well
and people living in these areas are enjoying a higher standard of living than
they had previously enjoyed. However, tax collection still remains a difficult
endeavor with compliance at only 70%. In order to improve the poorest areas in
China, policies and programs that are able to move this revenue to the poorer
areas will be needed. This can take the form of a better accounting system to
ensure that all taxes due the central government for infrastructure development
actually arrive there.
Banking Reforms, State Owned Enterprises and the Social
Safety Net
In order to put current economic reforms in
perspective, understand the recommendations made by the international economic
community, and fully address the quagmire of State Owned Enterprises (SOEs), a
more in depth look at the interconnectedness of the SOEs and the banking system
must be taken. We will attempt to do just that using the context of bank development
in the PRC, monetary policy, and ongoing reforms to SOEs.
Reform of the banking system in the
PRC has taken on similar characteristics to reform in other areas: i.e.,
gradual and experimental. At the beginning of reforms the financial sector in
the PRC could hardly be called a financial sector[20].
Financial sector development and implementation is a complex undertaking which
should include the development of institutions, instruments and markets[21].
Currently in the PRC, banking reform lags behind other areas of reform[22].
This is due to a complex array of policy decisions. No discussion of banking
reform in the PRC would be complete without an examination of the current state
of SOEs restructuring. Many macroeconomic initiatives are being put on hold in
order to bolster a failing state sector and postpone the social upheavals that
may be associated with the needed reforms of this sector.
Background
The Central Bank was established in
1984. In 1987 two additional universal banks were formed and non-bank
financial institutions were started. In 1988 new capital markets were formed
and the secondary trade of government bonds was allowed. In 1990 the Shanghai
and Shenzhen stock exchanges were opened. In 1992 all treasury bonds were
issued through underwriters[23].
At the end of 1994, the PRC had a total of 13 banks (of which 3 were
specialized banks and 3 were comprehensive banks). The new “financial system”
contained 20 insurance companies, 391 trust and investment companies and
greater than 60,000 credit cooperatives that operate in local areas[24].
During the summer of 1995 the central
government announced a series of new banking laws would be established. These
laws were the People’s Bank of China Law, the Commercial Banking Law, the
Negotiable Instruments Law and the Guarantee Law. Up until this time the roles
of each party in the framework of financial transaction hadn’t been clearly
defined. These laws begin to lay the comprehensive groundwork for financial
transactions[25].
The People’s Bank of China Law which was established in the summer of 1995
addresses the internal organization of the People’s Bank of China, its monetary
policy, its supervision and tries to establish its autonomy from provincial
and local governments (it is still under the control of the State Council).
This law has provisions in it for setting the prime lending rate, rediscount
window, amount of funds to be lent to commercial banks, and the trade of
treasury bonds, government securities and foreign exchange. It also bars the
People’s Bank of China from financing the budget deficits of the central
government and local governments. The Commercial Banking Law addresses the
mission of commercial banks. These are still under the guidance of the State
Council and still must issue policy loans (although the law also states that
any losses due to defaults on these loans will be compensated by the State
Council).
The Negotiable Instruments Law is
similar to the United States’ Uniform Commercial Code. The Guarantee Law deals
with mortgages, pledges, and liens. Both of these laws are hoped to standardize
and regulate credit transactions in the PRC[26].
Monetary Policy
Monetary policy in the PRC is
currently administered through a central “credit plan”. This plan, which is
administered by the State Council, sets credit quotas for each bank and also
facilitates direct bank financing of enterprises. In the current system the
major objectives of the specialized banks is to provide loans for various
projects, agriculture and foreign trade. The main recipients of these loans
are the state owned enterprises (SOEs). The terms and rates of these loans are
very favorable (usually 12%[27]).
Therefore the demand for these loans is higher than the supply and private
companies have to rely on other sources. This can take on various means and can
often lead to underground lending operations.
The convertibility of RMB has also been
undergoing changes. Prior to January 1, 1994, there were two money systems in
China. One for local use, the other for foreigners. These Foreign Exchange
Certificates (FEC’s) were redeemable only in state operated stores and
restaurants. Only higher level officials were able to use these and most
imported goods required the use of FEC’s. Since doing away with FEC’s , RMB
convertibility was relegated to official “swap shops”[28].
Now, with the correct permit businesses can use any large bank to exchange
money. However, the government has also begun to establish hard currency audits
as well as trying to force businesses to use the same bank for all of their
transactions (a way of tracking how much money is being exchanged). The new
convertibility does meet IMF requirements[29].
State Owned Enterprises and the Social Safety Net
As illustrated above, the banking system and
state owned enterprises are closely linked (see Table 7 in Appendix, page 24,
for financing of SOEs). According to Chinese government statistics, up to 20%
of the debt of state banks is bad debt. International estimates place this
figure at almost double that amount[30].
Recently in Jiangsu province, 30 SOEs declared bankruptcy telling the banks
they were not going to pay their debts. If all the banks in China did this it
would lead to bankruptcy of the banks[31].
SOEs account for only 34% of industrial output but consume 73.5% of government
investment[32].
Most have an average debt equal to 75% of total assets[33].
According to an Oxford Analytica study, in the first eight months of 1995, SOE
industrial output expanded by only 8.3% compared with a 13.7% increase for all
industry. And according to estimates, non-SOEs, on average, required less than
a third as much investment to achieve equivalent industrial output.[34]
These are serious problems. The ninth five year
economic plan (1996-2000) places priority on their eradication, calling for
SOEs to lay off workers to boost efficiency, and encouraging SOEs to “declare
bankruptcy if their liabilities outstrip assets, if they make long-term losses
and if they lose out in market competition.”[35]
Up until now current reforms and lessening of government controls have not only
not reigned in this problem but have also created new ones such as asset
stripping of the SOE by management, workers and local governments[36].
However, the central and local governments are
still hesitant to shut down even the most inefficient SOE. Currently, 7 out of
10 industrial workers work in a SOE. The SOE provides not only a job but
housing, education, pensions, insurance and often energy sources and commodity
shops on site. The World Bank estimates that only 56% of total expenditure by
SOEs is actually on wages, the rest is on “social spending”[37].
Therefore, any reform involving the SOEs must also involve reform and
development of a social safety net. Pilot programs have been started where
local governments create pension pools and are putting aside payroll taxes for
education, health and unemployment benefits. It is also important to note that
the question of “social security” reform is being worsened by additional
factors. Population in the PRC is progressively growing older. This phenomenon
can be attributed to increase in life expectancy due to better living
conditions and the one child per family policy.
How Should Reforms be Implemented?
Due to the interconnectedness of these areas of
society, many of these reforms need to be implemented simultaneously. In May of
this year the World Bank published a Country Study[38]
that attempts to address these issues. The following are proposed reforms from
this study.
1) Reduce the role of government in the
directing of resources.
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