do no worse than before. In sum, either option would leave taxpayers in the
52THE CHINESE ECONOMY
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existing lowest two rate bands at least as well off, with most of them actuallymuch better off, than under the existing rate schedule. Taxpayers in the highrate bands under the existing rate structure would obviously be made betteroff by either reform option under discussion (more so by the two-rate thanthe three-rate option).
With the basic monthly allowance set at RMB1,300, the flat tax rate thatwould produce a broadly revenue-neutral outcome would be 17 percent.16However, in this scenario, taxpayers in the existing 10 percent rate bandwould actually see their average tax rate rise by 0.5 percentage point; thosein the existing 15 percent rate band would also be more adversely affectedthan by either of the two options discussed above. Hence, the burden of theflat tax, as expected, falls largely on the lower-income taxpayers. Figure 3provides a comparative look at the different profiles of average tax ratesunder the various scenarios.
The three restructuring options illustrated above are chosen because theyseem to generate theoretically interesting outcomes. As noted earlier, thereare countless other restructuring options one could investigate using the simu-lation model by varying the level of the basic monthly allowance, the num-ber of tax rates, and/or the width of each rate band.
Concluding Remarks
A crucial part of any PIT reform usually has to do with restructuring thePIT’s progressive rate schedule: perhaps to simplify it (e.g., reducing thenumber of rates), to reduce marginal rates (e.g., aligning the top marginalrate with the corporate income tax rate), and/or to improve equity (e.g., in-creasing average progressivity by raising the basic allowance). However, anyrate restructuring inevitably entails important revenue and distributive con-sequences. A proper analysis of such consequences would require detaileddistribution data on taxable income and PIT revenue collection by rate band—the sort of data that are often not available in developing countries (such asChina), thus possibly hampering the quality of reform deliberations bypolicymakers in those countries.
This article shows that the data limitation could sometimes be overcome,at least partially, by an analytical modeling of the underlying distribution ofincome, for example, by assuming that the distribution follows the well-knownPareto distribution. It is further demonstrated that the Pareto distribution canbe readily applied to the China case in a straightforward manner. The ob-tained results of this particular application seem plausible and could thusinform policy deliberations on restructuring China’s PIT rate schedule on
wage income. However, the objective of the article is not to make specific
54THE CHINESE ECONOMY
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recommendations for such a restructuring, but rather to provide a relativelysimple illustration of how the Pareto distribution could be put to good ana-lytical use to address a PIT reform issue in a real country setting.
Postscript
After a protracted period of debate, China has doubled the level of the PIT’sbasic monthly allowance for wage income to RMB1,600, effective January1, 2006.
Notes
1. Xie’s statement is available at /ce/doc/cep2/200403173397.htm.
2. For an informative description of these taxes, see Li 1991.
3. Between August 1987 and the introduction of the present PIT in 1994 (effec-tively replacing the old PIT—see further below), the tax liability on wages and sala-ries of nonresidents was reduced by half.