Taxing times for city businesses

It has been two months since Shanghai started to replace its business tax with a value-added tax (VAT) on a trial basis in the transport industry and parts of the services industry.

Under the pilot scheme as well as the existing two VAT tax rates - 17 percent and 13 percent, two more are added - 11 percent and 6 percent. In China, different industry sectors attract different rates of VAT and business tax. The transport industry will apply the 11 percent VAT and the services involved will introduce a 6 percent VAT. So far the trial involves 120,000 businesses.

If the VAT is extended nationwide, the central government expects this to push the Chinese economy away from its heavy reliance on exports and investment, towards service industries. The reform signals China's efforts to change the structure of its taxation system.

The Ministry of Finance said that the Shanghai experiment is based on the city's services industry and the city's critical role in boosting the economy in neighboring regions. The experience here will be helpful when the reforms are extended nationwide.

According to the city's taxation authorities and some businesses cited by Xinhua News Agency, the pilot scheme has slashed the tax burden for most small taxpayers and a large majority of ordinary taxpayers have seen tax bills decrease.

However, the trial only affects a limited range of businesses. To try to shore up the small- and medium-sized enterprises (SMEs) at present being strangled by taxes and fees, the authorities will have to push harder.

First, for the hundreds of thousands of types of business not being favored, the thresholds for VAT and business tax should be lifted to give SMEs some room to breathe in a not-so-sound economic environment.

Second, under China's tax distribution system, both the business tax and the VAT have to be divided by the local and the central governments on a fixed share, with most of the business tax being paid to the local government and nearly all VAT going to the central government.

That's another reason why Shanghai is the first place to try this reform - the city's State and local taxation authorities are part of the same system here.

As well after the reforms, the current percentage of the tax to be distributed between the central and the local governments should be changed because, if not, local government will see holes in its income.

Third, clarification of the sectors that will be taxed is needed. Businesses nowadays tend to prescribe output in different ways to avoid traditional tax definitions. This reform will bring to these companies which span a wide range of activities, anything but a reduced tax burden.

Fourth, if policymakers are determined to help SMEs, they should think beyond tax reduction. They should ease the financing restrictions on SMEs. The initial goal of the tax reform is to give enterprises more capital to replenish their pool and expand their business.

Finally, business tax and the VAT combined account for over 40 percent of China's annual tax income. Should the business tax be cut and more industries levied by a lower VAT, will the tax burden be shifted to the man in the street?