Export Tax Rebates: China's Approach to Reforming the System

Here we will give the background to China's current tax rebate policy and then discuss the problems the current system is causing - both for the central government and China's exporters. The second part of this article focuses on recent solutions offered to address these problems, which culminated in the announcement of reforms by Chinese premier Wen Jiabao and the subsequent adoption of the reform programme. In our conclusion, we will evaluate the effectiveness of the proposed measures.

Background

An export tax rebate refers to the monies that the tax authorities return to a producer when its products are exported. To avoid double taxation on such products by China and the importing country, a rebate is given to the exporter to compensate (partially or in full) for the value-added tax (VAT) that has already been paid on production. Such rebates are a common international practice, and are permitted under the General Agreement on Tariffs and Trade (GATT) and the WTO - as long as the rebate does not exceed the amount of taxes paid to the domestic tax authorities. China has had such a system in place since 1985, when the Ministry of Finance issued the Administration of the Levy and Refund of Tax for Import and Export of Commodities Provisions. These provisions have greatly contributed to the tremendous increase in exports since economic reforms began: export growth has averaged 15.6% a year, which is six percentage points higher than average annual GDP growth. While the basic rate of value-added tax has remained 17% since 1997, the tax rebate for various products has fluctuated over the years. The rebates have been used to make Chinese exports more competitive, or alternatively to relieve fiscal burdens. Following the Asian financial crisis in 1997 for example, the government increased tax rebates for various products nine times between early 1998 and late 1999, thus compensating in part for the devaluation of many of east Asia's currencies. All kinds of products, ranging from raw materials to textiles to machinery, equipment and electronic products were affected.

The Fiscal Predicament

In recent years, however, the tax rebate system has become a heavy financial burden for the central government. A key reason for this is the extraordinary growth in Chinese exports over the past two decades - which was not only unprecedented but also unexpected. With it, expenditure on tax rebates has increased from Rmb1.8 billion in 1985 to Rmb107.2 billion in 2001. As a percentage of total expenditure by the central government this has equalled a rise from 2.3% in 1985 to a high of 38.5% in 1996, before falling to a still considerable 18.6% in 2001.¹ Such a growth in expenditures would not necessarily lead to an increased fiscal burden, because increases in tax rebates should strictly speaking follow increases in exports and VAT revenues. Evidence from China, however, indicates that tax rebates in most years have grown much faster than have either exports or VAT revenue.

This discrepancy is generally explained in two ways. First, China's preferential policies that aim to attract investors have generally tempered total VAT revenue. Second, cheating on tax rebates has been widespread. In fact, rebates may in some cases have been higher than the actual taxes paid on production. With the help of false invoices for example, rebates could have been sought for products that were never exported, or even never manufactured.

Another problem is the current system's payment mechanism. While VAT revenues are shared between the central and provincial governments in a 3:1 ratio, the burden for rebates falls wholly to the central government. The mechanism thus leads to a redistribution of funds in favour of provincial governments, and leaves the central government with a disproportionate part of the burden.

Partly as a consequence of the central government's increasing fiscal burden, the delay for pay out of rebates has lengthened considerably in recent years, putting pressure on exporters' profits and especially on their cash flows. At the beginning of each year the central government allocates a quota in its yearly budget, taking into account the expected increases in rebate payments. Delayed rebates carried over from earlier years are rarely taken into account due to the effect this would have on the government's finances, while predictions on the funds necessary for the year are in any case usually on the low side.

Furthermore, there is a great amount of administrative work involved in checking and paying out rebates, with the added difficulty that collection of VAT and pay out of rebates are done by tax bureaux at the district and municipality levels, respectively; as a result, figures on exporting enterprises' taxes and rebates often do not tally.

Some statistics indicate that 80% of China's export-oriented companies need to wait at least a year to receive rebates. The percentage is thought to be even higher for companies located in the booming coastal provinces of eastern China. Accumulated delayed rebates may reach Rmb247 billion this year according to one report; ² another estimate puts the figure in excess of Rmb300 billion.³ In either case, exporting companies face a considerable additional financial liability.

Initiatives for Change

The central government has recognized that in its current form the tax rebate system is becoming prohibitively expensive. But exports have come to account for a large share of China's overall economic growth and development (and account for a significant percentage of new job creation as well). The central government thus faces a dilemma: should it continue giving rebates, or even speed up rebate payouts, thereby jeopardizing its fiscal position? Or should it cut rebates or hold back on payouts, and risk a slow down in exports? Are there alternatives that will strengthen the system, relieve the government's fiscal burden and speed up rebate payouts?

Recently both the central government and local level administrations have shown an active interest in solving this problem. A crackdown on tax rebate fraud has been initiated as one step towards alleviating some of the pressures at a relatively low cost. The State Administration of Taxation announced in May 2003 that it had inspected more than 55,000 businesses, and had found Rmb8.65 billion in fraudulent tax rebates. Twenty criminals were sentenced to death, and 200 government employees or party members were punished. In one famous case, Zhang Baoxiang, a renowned entrepreneur and head of the state-owned Baoxiang Export and Import Co. in Hebei province, was prosecuted and convicted of receiving Rmb193 million in fraudulent tax rebates. Zhang was sentenced to life imprisonment.

Taxation bureaux around the country have taken action since 2001 to lessen the financial burdens that exporting companies have suffered due to delays in the processing of tax rebates. In one example, the Tianhe District State Taxation Bureau and the Guangzhou branch of the Shenzhen Development Bank have targeted foreign-invested enterprises (FIEs) with a new tax rebate policy. FIEs typically do not have the facilities to take out a loan to supplement cash flow while waiting for a tax rebate because they often lack the necessary collateral. Under the new policy, exporting FIEs in Tianhe may take out a one-year loan (which can be extended) against the expected rebates at 80% of the total, at an annual interest rate of 5.31%.⁴ While such loans do contribute to the enterprises' liquidity, they threaten to create new problems for banks - which are forced to take on new liabilities.

Initiatives such as the Tianhe plan may help to alleviate pressures, but calls for more comprehensive reforms have persisted. The tax rebate quota for 2003 was increased by Rmb30 billion to Rmb158.9 billion in July 2003, to speed up the rebate process and to help exporters hit by slow orders following the SARS crisis. Over the summer of 2003, the Ministry of Commerce and the State Administration for Taxation reportedly drafted proposals for broader reforms, and in August 2003 state media (including the China Daily and the People's Daily) proclaimed their expectations that comprehensive reforms were indeed at hand. Tax rebates will likely be lowered by 4% from their current 15.5% average, and on certain products will be eliminated altogether.

The Reform Programme

The reform programme adopted on October 13 2003 does not contain a general reduction of rebate rates, but it does support five "principles" that may lead to a meaningful adjustment of the rebate system. It was immediately followed by implementing measures from the State Administration for Taxation, which will cut rebate rates by an average of 3% as of January 1 2004.

The five principles of the reform programme are:

(a) increased support from the central treasury for export tax rebates;

(b) redistribution of responsibilities for export tax rebate payments;

(c) enhancement of measures to reform China's foreign trade system and export product structure;

(d) the central government's pledge that it will retain responsibilities for all payments due up to 2003; and

(e) reductions in the rate of export tax rebates.

The first principle indicates that the central government will continue to increase the rebate quota as necessary to prevent lengthening of delays, while the second addresses the problem of financial responsibility - provincial governments will receive 25% of VAT revenues but will also have to foot 25% of the rebates bill. The third principle seems to point to a general intent to restructure the economy so as to rely less on processed goods for exports and more on local demand (and imports, which bring in VAT), but may also indicate that producers will be allowed to export more of their own products rather than have import/export companies do so for them. Manufacturers are in a better position to carry the financial burden of delayed payments, and may be easier to supervise. The last principle, finally, will be implemented for now with cuts for various product categories but not for others, while in some cases the tax rebate has even been raised. Further cuts may be announced at a later time.

Conclusion

At a quick look, the reform programme does not seem to offer an "unprecedented and comprehensive reform package" as had been anticipated. Still, the tax rebate burden should be substantially reduced, while the increased quota will channel more funds more quickly to rebate payments and ease cash flow pressures for exporters. Sharing the responsibility for rebates between provincial authorities and the central government will further alleviate the latter's burdens - though it will create new financial liabilities for the provinces. China has chosen to take reform of its rebate system one step at a time.

Treading carefully will allow the government to monitor the effects of its measures, and make corrections where necessary. While some exporters may be affected, they will have time to adjust. The current reform's significance in alleviating international pressure on the Chinese currency is controversial. While the reform programme is seen by some as a bow to international pressure, the Chinese government has evidently implemented the programme to resolve a domestic issue - albeit one with much broader consequences.

Endnotes

1 See Cui Zhiyuan, "China's Export Tax Rebate Policy," China: An International Journal, September 2003, 1:2, pp. 333-349.

2 "China to Increase Tax Rebate Quota," China Daily,
June 17 2003.

3 "Tax Rebate Scheme to Be Reformed," Business Weekly,
August 10 2003.

4 "Guangzhou Launches Tax Rebate Loan for FIEs," at www.tcdtrade.com, October 15 2002.