China’s ‘Mr. Income Distribution’ Explains Common Prosperity

(Bloomberg) -- China’s push for “common prosperity” is not just about taxing the rich but also directing resources into rural areas and the lower-income group, according to one of the country’s most prominent experts studying income inequality.

The income gap has widened in the country over the past five years due to the rise of technology and financial sectors, and taxation has done little in narrowing the gap, said Li Shi, an economics professor at Zhejiang University, who has previously advised the government on poverty alleviation. He’s known in international academic circles as “Mr. Chinese income distribution” because of his work, according to the university’s website.

China’s top leaders have ramped up a campaign to address inequality in the country, pledging to grow the economy and better redistribute incomes. That would require raising taxes on individuals, including rolling out a property tax and inheritance tax, and boosting spending on public services in villages, according to Li.

Here are highlights from a recent interview with Li, which has been lightly edited for clarity:

How bad is China’s income inequality?

China’s income gap has expanded since the 1980s to reach a peak in 2008, when the Gini coefficient reached around 0.5. After that, it declined for a few years slowly, but has rebounded since 2015. Now it’s at a high level of around 0.47, according to an official estimate. The actual income gap could be larger, because the estimate is based on household surveys, which tend to under-represent high-income respondents. 

China is among the 20% most unequal countries in the world. Inequality is quite serious. The inequality within cities and within rural areas has also been expanding. Now urban residents roughly earn 2.5 times that of rural residents. The main problem is unbalanced development, with the household registration system restricting people’s movement and leading to all kinds of discrimination for migrant workers. 

In addition, China’s overall development strategy has focused on cities and neglected villages. A city-oriented strategy has led to public services concentrated in urban areas, hurt the economy in rural areas and the income growth of residents there.

What’s caused the rebound in China’s Gini coefficient in recent years?

Many new industries have emerged, especially the digital economy has expanded rapidly in recent years. Digital platforms, coupled with AI technology, have attracted highly-educated workers who enjoy high wages that also grow fast. In addition, China’s expanding financial industry has a strong monopolistic characteristic, which led to exceptionally high salary. Wages in other industries expanded slowly at the same time.

The rapid rise of income from assets also contributed to inequality, because high earners usually have more assets than low-income groups. Even though the government has dialed up taxation and transfer payments, it has failed to reverse the trend of a widening income gap. As China’s economy slowed, low-income groups suffered more from slower income growth, contributing to the wider gap. 

How do you evaluate Zhejiang province’s plan to achieve common prosperity?

Zhejiang’s plan has two priorities: achieving high-quality growth and sharing wealth. The policies are mainly on narrowing the income gap, equalizing access to basic public services and narrowing the urban-rural gap. The next step is to formulate specific implementation rules so they can make a real impact. For example, questions like whether it should launch a property tax or inheritance tax, and whether it should reform the personal income tax -- all of these details will need to be confirmed, which will take some time.

On one hand, we need to lift the income of rural residents and people in poorer areas. On the other hand, we need to enhance the quality of public services, including education and medical services. The goal is also about narrowing people’s development gap, giving children and teenagers more education opportunities to create higher-quality human capital. 

How should China reform its tax system?

China’s taxation has played a very limited role in redistributing income. There are two types of taxes: direct tax and indirect tax. Direct tax helps narrow income inequality, while indirect tax widens it. In China, the proportion of direct taxes is low, accounting for a third of the fiscal revenue, while indirect tax makes up two thirds. The ratio is usually reversed in developed countries. If we don’t enhance the tax structure, it would be difficult for taxation to adjust income distribution.

China needs to increase direct taxes, including income tax, property tax and inheritance tax -- all the taxes directly imposed on residents. It can increase the share of direct tax under the condition of maintaining the overall tax burden.

When will China roll out the property tax to more places?

Despite many discussions on launching a property tax, it still hasn’t entered the legislation process. It’s hard to tell how long this will take. Policy makers also have other considerations: a property tax could be a shock to the economy and create a negative impact. The economy is currently in a sluggish state and is still recovering from the impact of the pandemic. A property tax could be a blow to the property sector and weigh on housing prices. It’s a question whether the economy can withstand it. So such policies are best to be launched when the economy is booming.

What kind of social reforms are needed to address the urban-rural gap?

There’s a huge difference between public services in rural areas and cities, such as the quality of schools and teachers. We need to invest more resources in rural areas and poorer regions through public spending. The government also needs to use more of its expenditure on improving people’s livelihood. We need to make greater use of taxes to adjust high earners’ income and use transfer payment to improve low-income groups’ earnings.

What role should private businesses play in promoting common prosperity?

The private economy should play an important, positive role. That’s the experience from Zhejiang, which has lower inequality with better growth. The private economy, especially small businesses, played a critical role in that. Zhejiang’s private businesses are dynamic and provided lots of jobs, attracting workers from other provinces. Without the private economy, common prosperity is just an empty slogan. 

How will life of the rich be affected?

Rich people’s lives won’t change much. Top leaders have repeatedly said that common prosperity is not egalitarianism or robbing the rich to feed the poor. Rich people may have to make more contribution in terms of taxes and charitable donations. But paying 5% or 10% more taxes won’t bring a huge impact to their lives.

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With assistance from Bloomberg