To illustrate the comparison between Chinese and U.S. government spending, the chart below shows the development of total government expenditure in China and the U.S. in the 21st century – this data includes military as well as civilian spending. As can be seen, the share of China's government expenditure in the economy already rose significantly, from 17.1 percent of GDP to 24.9 percent, but the U.S. share also rose – from 32.6 percent of GDP to 38.8 percent. Therefore the gap between the U.S. and China only shrank from 15.5 percent of GDP to 13.9 percent. China's proportion of government spending in GDP remains far below the level of an advanced economy.

Given these trends, the relation between social stability and taxation is evident. If China's government expenditure is not raised towards the levels of an advanced economy it is impossible to create an adequate health and social safety net. In that case social instability would be inevitable – a sense of insecurity is already a complaint and a restraint on consumer spending. But if tax increases faster than GDP, the necessary consequence of a rise in the percentage of state spending in GDP, then the question of who is to pay these tax increases will inevitably become a key factor in social stability and perceptions of social justice.

Attempts to avoid this fundamental issue by expedients such as local government land sales are not only inherently temporary in character but have undesirable side effects such as attempts to inflate land values and therefore housing costs.

Turning to how taxation is to be reformed to meet such increases in government expenditure, the first principle, as is widely pointed out, is that there must be a shift from indirect to a direct taxation – attempts to finance increases in government spending primarily via increases in indirect taxation would both increase the relative tax burden on the least well off sections of the population and be inflationary. China indeed shows the characteristic features of a developing economy in being far more dependent on indirect taxes than an advanced economy. To take an extreme example only 3 percent of India's population pay income tax compared to 49 percent in the U.S. At the time of China's income tax reform in 2011 only 8 percent of its population paid income tax – scarcely higher than India and far from the level of an advanced economy. The expansion of the scope of direct taxation that is coming in China is evident from this data.

Income tax is the dominant form of direct taxation both in China and other countries, and in the U.S. it is integrated with capital gains tax – although in other countries they are separate. However China currently lacks two direct taxes that would be taken for granted in a developed economy – a universally applied property tax and an inheritance tax.

On direct taxation China has a key decision on principle to take. One of the reasons the U.S. tax system is so efficient in its collection, in the sense of being hard to avoid, is that it rests on two key principles. First a U.S. citizen must pay U.S. taxes on their income no matter in which country they are living, and second that if they attempt to evade this by renouncing U.S. citizenship they have to pay an "exit from citizenship tax" (expatriation tax). Given the efficiency of collection in the U.S. tax system China would be well advised to follow these U.S. principles.

In contrast to the complexities of personal taxation, the principles of company taxation are simple. Statistics show the majority of economic growth is produced by investment. Company taxation should be designed to create a low rate of taxes on investment with a high rate of taxation on anything that subtracts from investment such as dividend payments.

Naturally, the framework outlined above, which constitutes the minimum to make a transition towards the tax system of an advanced economy, is far more than could be implemented at either the recent Third Plenum of the Central Committee of the CPC or even at a series of Plenums in the near future – it represents a comprehensive series of tax reforms to be implemented over a prolonged period. Nevertheless it indicates a direction of travel China will have to go down as it moves towards becoming an advanced economy.

The author is a columnist with China.org.cn. For more information please visit:

http://www.by33321.com/opinion/johnross.htm

Opinion articles reflect the views of their authors, not necessarily those of China.org.cn