Tax and hukou hold China back

Author: Ryan Manuel

John Garnaut’s piece in the SMH argues that ‘making taxes more equitable is China’s biggest challenge’.

Garnaut, using an article by Justin Yifu Lin in the recently-released China Update book, argues that ‘perhaps the answers.. lie with a market-driven “primary” distribution of resources’.

He sees this as solving Lin’s dilemma of a price system which is not ‘sufficiently and flexibly reflecting the relative scarcity of every Factor’ of production. Huang Yiping, as reported in Garnaut’s article, suggests that ‘prices for labour, capital and land are still significantly depressed’.

But the ‘market driven primary distribution of resources’ suggested by Garnaut is far from feasible at present. The problem is that you can’t really have market-driven distribution of resources, especially labour, when the hukou system (of household registration) artificially distorts the market for labour.

Migration permanently across provinces or into large cities in China is highly difficult. The central government has encouraged migrants to move to smaller rural cities. Yet small cities in poorer provinces are less attractive destinations for migrants. These areas have poorer social services. And migrant workers, wherever they go do not qualify for access to basic social services.

The constraints of the price of labour and other factors are exacerbated by the current tax system. The Tax-Sharing System instituted in 1994 has created inequities both vertically (between the central and local governments) and horizontally between provinces. This has a highly negative effect on the provision of social services in poorer provinces.

Garnaut says that the central government has increased social transfers in the past few years. Yet, fiscal transfers often reinforce rather than reduce disparities. The more economically successful a province already is, the more likely it is to benefit from current tax-based transfer methods. This is due to the Chinese government’s use of a tax rebate system of fiscal transfers.

Fiscal shortages mean poorer provinces already parlous social services lag even further behind those of more developed areas. Thus, many more people wish to move to wealthier areas than are
permitted under the current hukou system but are unable to, distorting the price for labor. Tax reform is essential to tackle this blockage before China can seek to, as Garnaut says, find ‘answers (from) a market-driven distribution of resources’.