Why You Don’t Always Get What You Pay for

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

China's leaders are about to makeenormously influential changes tothe country's tax laws. At the 17th NationalCongress last October, PresidentHu Jintao pledged thatthe government would establish abetter revenue system. He hoped, nodoubt, to mollify those whose boatshaven't yet floated in the rising economictide.

Beijing announced that, onMarch 1, it will enact a reform underwhich 70 per cent of the mainlandworkforce will pay no income tax.Only 50 per cent now pays the tax –remarkable enough in itself – butonce the new policy goes into effect,fewer than a third of workers will bearthe costs of government directly. Thetax threshold will rise to 2,000 yuanper month from 1,600 yuan.

Chinese workers are justified intheir wish for lower taxes, but the taxcuts should be accompanied byspending cuts, too. When the governmentgives people services they don'tpay for, there's no limit to the demandfor government growth. Paradoxically,making something freemakes it very expensive. And, asAmerican leaders have learned, disconnectingfinancial inflows fromoutflows can cause problems downthe road. Any system in which onegroup of people is made to pay substantiallyfor services they don't receiveis likely to create lasting ill willand entrenched political intereststhat can take on lives of their own.

When US president Franklin Rooseveltand a Democratic congress enactedSocial Security in 1935, theythought there was no better way torestore Americans' hopes in themidst of the Great Depression than toguarantee some retirement incomefor everyone. Fast forward 73 years,and Social Security is the largest governmentprogramme in the history ofcivilisation. At around US$600 billionper year, it spends almost as much asthe Chinese government takes inthrough taxes in total.

Social Security has become amassive wealth transfer from youngworkers, who often have little disposableincome, to old retirees, many ofwhom don't need it. The programmeis financed by its own tax but, withinthe next decade or two, it will beginpaying out more than it takes in.Many politicians privately wish theycould fix the programme, but theretirees are a well-organised politicalconstituency. If a public official utterseven the slightest peep about"reform", they'll move heaven andEarth to stop him.

Paying taxes is no fun but, in asense, it makes a citizen a stakeholderin the government, by putting him inmind of the fact that, if he wants moregovernment, he has to pay for it.When you buy something in Britainand pay the value added tax on it, yousee the price of government. Europeansmay not yet be ready to cast offthe vestiges of their burdensome welfarestates, but you can bet they feelthe pinch in their pay cheques.

The gargantuan Chinese economycould probably bear the costs ofan income tax cut. Official statisticsshow that the higher income taxthreshold will reduce annual revenueby 30 billion yuan, but income taxrevenue rose 12.9 per cent last year.According to Xinhua, revenue for2007 is expected to exceed 5 trillionyuan. Compare that to the 113.2 billionyuan in 1978, before Deng Xiaoping'seconomic reforms.

Whatever the system of government,it's important to maintain linksbetween who pays and who benefitsfrom a programme. In passing theirindividual tax reforms, Chinese officialsmay be charting a course not unlikethat of a petrostate, where thegovernment uses revenue from thenon-tax sources of oil royalties toprovide massive subsidies and publicwelfare programmes while denyingtheir citizens the rights of propertyownership and political free speech.

Tax cuts are a good thing, but notwhen they're essentially entitlements,allowing some to benefit bygovernment programmes entirely atothers' expense. In the end, entitlementsengender an entitlementmentality, without addressing a people'smost deeply felt needs.

David Donadio

David Donadio is a writer and editor at the Cato Institute.