Why You Don’t Always Get What You Pay for

January 16, 2008 • Commentary
This article appeared in the South China Morning Post on January 16, 2008.

China’s leaders are about to make enormously influential changes to the country’s tax laws. At the 17th National Congress last October, President Hu Jintao pledged that the government would establish a better revenue system. He hoped, no doubt, to mollify those whose boats haven’t yet floated in the rising economic tide.

Beijing announced that, on March 1, it will enact a reform under which 70 per cent of the mainland workforce will pay no income tax. Only 50 per cent now pays the tax – remarkable enough in itself – but once the new policy goes into effect, fewer than a third of workers will bear the costs of government directly. The tax threshold will rise to 2,000 yuan per month from 1,600 yuan.

Chinese workers are justified in their wish for lower taxes, but the tax cuts should be accompanied by spending cuts, too. When the government gives people services they don’t pay for, there’s no limit to the demand for government growth. Paradoxically, making something free makes it very expensive. And, as American leaders have learned, disconnecting financial inflows from outflows can cause problems down the road. Any system in which one group of people is made to pay substantially for services they don’t receive is likely to create lasting ill will and entrenched political interests that can take on lives of their own.

When US president Franklin Roosevelt and a Democratic congress enacted Social Security in 1935, they thought there was no better way to restore Americans’ hopes in the midst of the Great Depression than to guarantee some retirement income for everyone. Fast forward 73 years, and Social Security is the largest government programme in the history of civilisation. At around US$600 billion per year, it spends almost as much as the Chinese government takes in through taxes in total.

Social Security has become a massive wealth transfer from young workers, who often have little disposable income, to old retirees, many of whom don’t need it. The programme is financed by its own tax but, within the next decade or two, it will begin paying out more than it takes in. Many politicians privately wish they could fix the programme, but the retirees are a well‐​organised political constituency. If a public official utters even the slightest peep about “reform”, they’ll move heaven and Earth to stop him.

Paying taxes is no fun but, in a sense, it makes a citizen a stakeholder in the government, by putting him in mind of the fact that, if he wants more government, he has to pay for it. When you buy something in Britain and pay the value added tax on it, you see the price of government. Europeans may not yet be ready to cast off the vestiges of their burdensome welfare states, but you can bet they feel the pinch in their pay cheques.

The gargantuan Chinese economy could probably bear the costs of an income tax cut. Official statistics show that the higher income tax threshold will reduce annual revenue by 30 billion yuan, but income tax revenue rose 12.9 per cent last year. According to Xinhua, revenue for 2007 is expected to exceed 5 trillion yuan. Compare that to the 113.2 billion yuan in 1978, before Deng Xiaoping’s economic reforms.

Whatever the system of government, it’s important to maintain links between who pays and who benefits from a programme. In passing their individual tax reforms, Chinese officials may be charting a course not unlike that of a petrostate, where the government uses revenue from the non‐​tax sources of oil royalties to provide massive subsidies and public welfare programmes while denying their citizens the rights of property ownership and political free speech.

Tax cuts are a good thing, but not when they’re essentially entitlements, allowing some to benefit by government programmes entirely at others’ expense. In the end, entitlements engender an entitlement mentality, without addressing a people’s most deeply felt needs.

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