The current China income tax laws system is based on the 1994 tax system reform. It is composed of three coexisting parts which regulate respectively individual income tax, income tax on Chinese-invested enterprises and income tax on enterprises with foreign investment and foreign enterprises. This income tax law system has played an effective role in enhancing our economic opening to and cooperation with the world, in safeguarding our national economic rights and interests, and in modulating social income gaps and moderating social unfairness. With China entering WTO and the deeper reform in the socialist market economy system, the not-noticed-yet-still-existing drawbacks of current income tax laws become quite apparent. How shall we carry out this reform? Such an issue becomes a hot topic of the public at the present time.

       I.Drawbacks of current China income tax laws

       While we are agreeing to the positive effect of the current China income tax laws system, it should be reasonably realized that, due to the economic, political and legal reasons, certain drawbacks still exist strikingly.

       i）．Drawbacks of Enterprise income tax law

       The enterprise income tax law has enjoyed significant progress with the reform, yet with the development of market economy and the collectivization, regionalization and globalization of the world economy, the drawbacks in the framing of such a Dual-System[1] enterprise income tax laws system has become apparent with the problems it has been brought about in the implementation, they may be roughly listed as below:

       1.The dividing condition of enterprise income tax is unreasonable.

       According to the 1994 tax system reform, the enterprises are divided into to classes, i.e. those directly subordinate to the central government and those to the local government, and accordingly, their income taxes are subordinated to the central government and the local government respectively. Such a classification of enterprises is a symbol and an outcome of the traditional planned economy; it lays emphasis on the relationship between an enterprise and the government. This tax-sharing system may render the public a misunderstanding of the relationship between taxation division and partitioning of investment yields, and this misunderstanding imposes as an obstacle to establish an appropriate income tax partitioning scheme.

       This tax partitioning based on administrative subordination has led to the fact that sate-owned enterprises may enjoy a particular governmental consideration, which will render a differential system environment for different enterprises and means an intentionally designed unfairness. The central government may manipulate an advantage for those enterprises directly owned by it, while the local government may do the same by a flexible manner for its enterprises. At the same time, the strictness and sanctity of enterprise income tax law is violated as an immediate result. In addition, since the tax partitioning is based on administrative subordination, the tax collection and law enforcement come under the authority of different levels of governments. That will cause those ostensive problems that the collection cost is increased, the competent level of the state treasury will be confused, the enterprises may be disturbed by the cross collection and administration and so on. A deep-seated problem is that every level of government seems to be assured of direct administration of the income tax.

       2.The tax collection and administration system for enterprise income tax is far from being scientific.

       This can be seen especially in the tax collection and administration system for Chinese-invested enterprise income tax. Firstly, the place of tax payment is not uniformed. The Provisional Regulations for Enterprise Income Tax provides that the independent accounting enterprise shall pay its tax locally, yet it also provides that the industries of railroad, civil aviation, postal service and finance may respectively collect the tax as a unit. The above provisions may lead to some inconvenience and conflicts. Secondly, there are too many kinds of tax-collecting authorities, especially with regard to Chinese-invested enterprises. Concerning such enterprises, the power of collection and administration of the income tax on the non-state-owned ones is allocated to the local tax authorities, whereas the income tax on the state-owned enterprises, nominally collected and administrated by tax authorities, is actually controlled by different levels of revenue organs. This situation will inevitably lead to inconsistency in tax collection and administration and will weaken the tax-collecting function of the authorities.

       The dual-system taxation has in effect increased the cost of collection and administration. According to the current situation, most of local tax authorities with a relatively high rank have set up their taxation departments concerning foreign affairs. Though theoretically they carry out a uniform measure for the income tax on both Chinese-invested enterprises and FIEs or foreign enterprises, they actually set up two different systems of organs and rules. That has virtually increased the cost of collection and administration. It also violates the principle of efficiency in taxation administrative and the WTO principle of national-treatment.

       3.The relationship between the taxable income and the accounting income is unclear.

       At present time, there is a gap between the taxable income and the accounting income. The Provisional Regulations for Enterprise Income Tax and the Income Tax Law Concerning FIEs and Foreign Enterprises have both stipulated that when, applying to its own accounting method, the accounting income of a taxpayer is not agreeable to the applicable provisions of tax law, the income tax shall be determined by the applicable provisions. Yet there are some practical troubles in implementing such provisions: the tax authorities are not capable of establishing a wholly independent standard for the tax counting and collecting. The conflicts between relevant rules and policies are yet to be resolved, especially to the state-owned enterprises.

       4.The effect of the preferential policy on the enterprises income tax is not satisfying.

       The purpose of inviting foreign investment is to bring in capitals with advanced technologies and to develop our infrastructure and bottleneck industries. However the Super National Treatment of preferential tax policy on the enterprises income tax provided for the FIEs has not live up to that aim. First, the industrial structure of foreign investment is not rational and the general quality of foreign investment is relatively poor. Those enterprises of foreign investment are almost labor intensive instead of technology or capital intensive ones. Second, the economic disparity between different regions is aggravated. The preferential policy on foreign-related enterprises has evolved a ladder-like income tax rate, i.e. from special economic zones to coastal economic development zones and further to common inland regions, the tax rate becomes higher and higher. There had already been a considerable economic disparity between the eastern and western parts of our country due to historical and geographical factors, this preferential policy will bring about an unfair competition and further enlarges the economic disparity between different regions.

       In recent years, the state government has maintained a policy-based support for the western development. In terms of the preferential policies, the western part is enjoying a more favorable support than the eastern part. Yet due to the poor natural conditions and poor infrastructure, the western part is still not able to compete with the eastern part despite the preferential policy on the investment, and this preferential tax policy still can not effectively attract capital from the eastern part to the western part.

       5.The occurrence of double taxation infringes on the principle of fairness.

       According to current income tax laws system, a company and its shareholders shall be taxed respectively in terms of enterprise income tax and individual income tax. Double taxation hence occurred. This will influence the company’s decisions on dividend or debt[2] and the likes and consequently do harm to the distribution of resources and the social economic security.

       ii）． Drawbacks of individual income tax law

       Though the individual income tax law of China has come into the track of general international practice, there are still some parts that do not accord with this track. China individual income tax is not harmonious with international practice in several respects as follows:

       1.The item-categorized tax is not suitable.

       As to individual income tax, China adopted an item-categorized system and a collection measure of withholding at source since 1980s when it established its first individual income tax law. It was suitable at that time when the individual income was generally low and the collection technique of the taxation organs was simple. With the development of national economy, the individual income is rising to a new level and the number of taxpayers is rising as well. On the other hand, the collection technique of the taxation organs is enhanced a lot. Under this condition, the individual income tax shall function as a method to modulate individual income, and the principle of levying tax based on the actual paying ability of taxpayers shall be paid adequate attention to. The previous item-categorized tax is thus not compatible with this new trend; it does not comply with the principle of levying tax basing on the actual paying ability of taxpayers, and may even violate the constitutional provision of basic living rights.

       2.The design and structure of tax rate is not well-proportioned.

       According to the international general practice on income tax, the comprehensive income is taxed by progressive tax rates in most countries. Those incomes which cannot be listed into the comprehensive income will be taxed by differentiated proportioned rates. Since middle 1980s the taxation theory of supply-side economist has begun to exert its influence, and the western developed countries, led by U.S., have finished their reforms of income tax law to lower tax rate, to reduce the number of grade of tax rates and to broaden tax base. This reform trend is impacting some developing countries now. As to the current rates of China income tax, there are shortcomings in three aspects. First, the classification of progressive rates levied on income in excess of specific amounts is designed too complicated. Including those individual income taxes on the investors of individually invested enterprises and jointly invested enterprises, this classification is made up of four general categories, whose tax rates are further differentiated. Second, there are too many grades of progressive rates on the income from wages and salaries, and the marginal rate is too high. Third, there is a problem of compatibility between the design of tax rates and the upgrading or degrading of the tax rates and expense deduction. That will bring about the unfair tax burden and the trouble of complicated calculation, especially concerning the income from remuneration for personal service and payment for writings. [3]

       3.The taxation treatment is unfair and the deduction of expenses is irrational.

       Concerning the Individual Income Tax Law of China, the unfair treatments may be generalized as below: First, the common salary and the remuneration for personal service are treated distinctively though they are both the payment for personal labor. Second, Income from wages and salaries shall be taxed at rates ranging from 5% to 45%, while income from royalties, interest, dividends, bonuses, lease of property, transfer of property and the likes, all of which are not paid for the labor, shall be taxed at a flat rate of 20%. The sharp distinction of tax rate will affect not only the principle of payment on the basis of labor, but also the sense of fair taxation. Third, while dividends and bonuses shall be taxed, the interest of national debt and financial bond is free of taxation. It is unfair in that they are all income from other than labor.

       As to the current individual income tax, there are two measures of deduction: one is in quota deduction and the other is rate deduction. Income from wages and salaries shall be deducted 800 CNY as tax monthly, while the payment for writings, the remuneration for personal service and the likes shall be taxed in a combined way of quota deduction and rate deduction. It is not easy to calculate the final tax this way and may overlook the actual burden on the taxpayers. Now that the related reform in education, housing and social security is advancing step by step, the individual burden is different. So the current individual income tax has overlooked this difference of burden and fails to provide reasonable deduction for taxpayers according to their tax payment capability, the taxation principle of fairness will not be virtually carried out accordingly. On the other hand, 800 CNY as a monthly deducible amount is obviously too low in respect to the current general salary income. In fact, this number has been raised to 1000 CNY, 1400 CNY or even 1600 CNY. This expediential measure certainly infringe on the consistency and authoritativeness of income tax law.

       4.The technique of collection and administration falls rather behind.

       As to the tax collection, withholding and remitting tax and filing tax are the two ways. Due to the incompleteness in tax filing, tax auditing and inspection and tax withholding and remitting, the collection and administration can not live up to this expectation. First, the process of tax filing is not integrated. There are no practical and integrated tax filing rules available, nor individual property registering and inspecting system. Besides, there is too much cash transaction in the real practice as a result of the loose bank cash control system, all these contribute to the impossibility for the taxation authorities to inspect the individual income and property, quite many virtual taxpayers may easily avoid the obligation of paying tax. Second, the method of withholding and remitting tax is not practicable either. According to the applicable individual income tax law, the enterprises (units) or persons who are under obligation to withhold and remit tax shall fulfill such an obligation and make special notes for the future inspection before they pay the taxpayer the amount taxable. Actually, there are no systematic and feasible measures to assure such a fulfillment and pertinent tax laws become a dead letter.

       II.Trends of China income tax laws reform

       What shall we do to perfect China income tax laws in consideration of its drawbacks? The author believes that the formulation of a uniform enterprise income tax law and the perfection of individual income tax will be the trend to reform China income tax laws.

       i）．Formulation of uniform enterprise income tax law

       One of the key steps in establishing modern enterprise system is to transform the present enterprise system gradually into the one based on a perfect legal person system, characterized by limited liability, whose major form is corporation. Similarly, China's enterprise income tax system shall step towards a uniform income tax on enterprise legal persons. The two laws, the Provisional Regulations for Enterprise Income Tax, specially applying to Chinese-invested enterprises now, and the Income Tax Law concerning FIEs and Foreign Enterprises, specially applying to Foreign-invested enterprises, should be regrouped into a uniform income tax law on enterprise legal persons.

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       1.To uniform the taxpayers by choosing a mode of uniform enterprise income tax law

       The academic circle presents two main opinions on the modes of uniform enterprise income tax law. One is that China's enterprise income tax system shall work on the concept of enterprise legal persons; the other is that the status of a taxpayer shall still be determined on whether it keeps separate accounts, i.e. to continue the present mode. Our opinion is that the uniform enterprise income tax law would be better to be named as Corporation Income Tax Law, which means the legal person enterprise defined by the civil law is a standard taxpayer. We may take advantage of this mode: the taxation problems involved with headquarters and branches, parent companies and subsidiaries will be resolved, the distinction between enterprise income tax law and individual income tax law will be more clarified since the former is aimed at legal persons while the latter is aimed at natural persons, and this mode is harmonious with international practice. At present a general mode of income tax law in the world is in this way; corporation income tax and individual income tax are the two standard segments by determining whether an enterprise is of a legal person. [4]

       2.To uniform the tax rate

       As to the determination of tax rate, the academic circle presents two main opinions. One is that the present unified tax rate shall be continued for its merits of calculating simplicity, enforcement transparency and common fairness. Concerning the rate itself, the present figure of 33% is agreed on by some scholars, while some others go in for a smaller figure such as 30% or 27%. The other opinion is that the fixed tax rate should be flat rates combined with graded progressive rates. This latter design is obviously more scientific, yet it lacks enforcement transparency and may confuse the taxpayers. So a rather unanimous opinion in the academic circle is in favor of a unified tax rate. Considering the present tax rate in China, 25% on Chinese-invested enterprises and 24% on FIEs, and that in the neighboring countries, 37.5% in Japan, 30% in Thailand, 34% in South Korea, and 27% in Singapore, we may conclude herein that 25% is a proper figure.

       3.To uniform the tax base

       The present enterprise income tax has stipulated the way to calculate the taxable amount of income, that is to say, enterprises shall adjust the profit calculated in accordance with accounting system to be taxable amount of in accordance with tax law regulations. Yet generally speaking the determination of the tax base is rather closely dependent on the enterprise financial accounting system, which leads to the weak rigidity and low standardization in the calculation of taxable amount of income. So the uniform enterprise income tax law should provide the exact provisions on the subject and standard of the deduction from the taxable income. (i) salary. Salary shall be deducted in the amount of taxable salary at the present time by applying standard for FIEs in Chinese-invested enterprises; yet in the long run, after enterprises have perfected their self-restricting system, salary shall be deducted in the actual amount (ii) donation, which also shall be deducted, in accordance with certain rate and scale, by applying standard for FIEs in Chinese-invested enterprises. (iii) depreciation, standard for FIEs shall be preferred to have a shorter period of deprecation in accordance with the capability of the state revenue, in this way, enterprises may accelerate the replenishment of fixed assets and facilitate the technological advance. There are also many shortcomings in the determination of tax base which need to be rectified in the future unification of enterprises income tax laws.

       4.To adjust the preferential policy on income tax

       The preferential policies on income tax are a handicap to combine the two income tax regulations, which are applicable respectively to Chinese-invested enterprises and to Foreign-invested enterprises. The present income tax law manipulates some complicated preferential policies on the enterprises of different ownership, in different regions, on different trades and productions. Though those preferential policies have played an active role to some extent, and some of them have to be kept in order to maintain their coherence and consistence, yet they are still the handicap to set up a fair competition environment and to perfect a general investment environment. So in light of the requirement of the development in the reality, all the preferential policies must be adjusted to a uniform condition. Especially after China entering WTO, it is a popular proposal to handle FIEs and foreign enterprises with Non-partitioning Treatment. The way to uniform the policies should follow the principles below: Under a general uniform of enterprise income tax, some special preferential policies may be used on the FIEs and foreign enterprises due to special causes, e.g. those enterprises badly needed for developing some special industries of China, or directly reinvest of FIEs, profit collection, tax withholding. The basic industries and high and new technology industries shall be supported and the trend of foreign investment shall be led properly in a selective way. We may take examples from the general international practice, and treat the FIEs and foreign enterprises with a policy of encouraging, permitting, restraining or forbidding in a selective way, in an effort to adopt, to extent possible, national treatment taxation policy to FIEs. Such selective preferential policies are not contradictory to the fact that we will handle FIEs and foreign enterprises with Non-partitioning Treatment. On the other hand, we may pay proper attention to the development balance between different regions under the uniform income tax law. Considering the imbalance of the economic development among the quite different regions of China, some special preferential policies is still necessary on some special regions, e.g. the minority nationality regions, the five special economic zones and Shanghai Pudong New District.

       ii）． Perfection of individual income tax law

       The reform of individual income tax laws of the developed countries in a recent decade is generally focused on the Fairness and Efficiency. The priority of such reform is to increase tax base, lessen preferential policies and block tax evasion[5] . In light of the practice abroad and our conditions, it is advisable to perfect individual income tax law in certain aspects as below:

       1.To complete the transition of item-categorized income tax system to a comprehensive classified income tax system

       Theoretically there are three kinds of income taxation systems: item-categorized income tax system, comprehensive income tax system and comprehensive item-categorized income tax system. The standpoint of item-categorized income tax system is that income with different nature is taxed differently. That is in the convenience for controlling tax source and saving the collection cost. Yet it does not match the principle of levying tax based on the actual paying ability of taxpayers. On the contrary, the comprehensive income tax system meets the principle of levying tax based on the actual paying ability of taxpayers, yet the collection process is very complicated and may render tax evasion. The system of the comprehensive item-categorized income tax has gained world-wide recognition. It represents a trend of combination of the above two systems. The 1980 Individual Income Tax Law of China once took advantage of comprehensive item-categorized income tax system. Yet the 1987 Provisional Regulations on Individual Regulatory Income Tax used item-categorized income tax system and later the amended Individual Income Tax Law kept item-categorized income tax system. In light of the development trend, the future Individual Income Tax Law should utilize comprehensive item-categorized income tax system. Since the item-categorized tax system, though easy to be manipulated, does not pay proper attention to the taxpayer’s actual paying ability, and the comprehensive income tax system, though having paid such attention, will differentiate between the incomes tax form different incomes. The comprehensive item-categorized income tax system combines the above two advantages. Regrouping wages, salaries, income from contracted or subcontracted operation of enterprises or institutions, income from lease of property, and income from transfer of property into a comprehensive income, they should be taxed at progressive rates after a reasonable expense deduction. As to other income, proportional tax rate should remain applicable. In this way, the comprehensive item-categorized income tax system will work far better in China.

       2.To better the system on taxpayers

       Under the frame of WTO, the taxpayers in every country are individuals and families. In terms of fairness, treating the family as a taxpayer is a rather proper way to tax those incomes from other than labor, e.g. interest, dividend, bonuses and so on. When an individual is treated as a taxpayer, the collection mode of withholding at source will overlook his tax-paying ability. On the other hand, when a family is treated as a taxpayer, all those incomes will be added into family income and will be properly deducted before paying tax. This will well match its tax-paying ability.

       Whether to treat individuals or families as taxpayers mainly depend on the objective value of individual income tax at a particular time. In terms of national revenue, it makes no substantial difference to treat an individual or a married couple as the taxpayer. In terms of efficiency, treating an individual as the taxpayer will influence his investment and work choice, while treating a family as the taxpayer will influence far more factors in that a family is a basic unit of the society and most expense, deposit and investment is carried out in the name of a family. In terms of fair distribution, the difference between individual incomes will inevitably be represented by the difference between family incomes, so the regulation on income can be focused on the family income in the end. Treating a family as a taxpayer will ensure that the families with the same economic income will be taxed the same, which is the most significant advantage. And some social policies may be carried out in this way. For example, tax deduction and exemption may be carried out to the olds and children. In addition, with respect to the current employment pressure, treating a family as a taxpayer will urge the low-paid member of a family to quit his job willingly and hence mitigate the employment pressure.

       3.To broaden tax base further and to decrease tax rate

       To broaden tax base means to enlarge tax sources and the final financial income. This is a common measure for many countries to have taken in their tax reform since 1980s. Considering the fact that the decreasing tax rate has caused the decreased financial income, such a measure seems more important. The revised Individual Income Tax Law provides measures to broaden tax base, yet it is not broad enough, and should be even broader, in accordance with the improvement of economy. One of possible measures is to raise some new taxable income, such as agricultural production and business income and future market income. A second measure is to cancel or decrease some expense deduction concerning some income, such as income from contracted or leased operation of enterprises or institutions. A third measure is to collect tax in advance on the individual income from the interest of national debt and financial bond. In addition, to lower tax rate and to reduce the number of grade of tax rate should be taken into account.

       4.To normalize the expense deduction before income taxation and to take the paying ability of taxpayers into account

       Under the frame of WTO, the deductible objects of the tax deduction in every country generally include cost expense, the means of livelihood and individual tax exemption. The expense deduction is generally in the mode of being listed according to its real condition or being listed within a limitation. The deduction of the means of livelihood is the kernel part of the deducible objects and is decided on the social situation in terms of aged status and marital status. Individual tax exemption is provided due to the principle of levying tax based on the actual paying ability of a taxpayer. With the development of individual income tax law, the deduction system has already become a symbol of the quality of the law itself.

       The individual income tax should better the system of expense deduction before income tax in the aspects as below: (i) Income from different taxpayers may cost different, so the expense deduction should be differentiated. (ii) The imbalance between the eastern and western part of China should be taken into consideration, and there should be a properly differentiated tax index concerning this imbalance. (iii) Such expense deduction should differentiate between those families supporting their olds and those free of such supporting, for their actual living burdens are not the same. As a result, the expense deduction stipulated in the individual income tax is not a fixed figure, but a floating one against the actual national exchange rate between currencies, overall price level, the cost of the means of livelihood and the likes. Meanwhile, the law should stipulate a uniform deduction standard for Chinese citizen and the foreigners. [6]

       5.To turn the current collection mode of withholding at source into a mode based or mainly based on tax declaration

       The prevailing tax collection mode in every country is the combination of withholding at source and tax declaration. Since both modes have their advantage and disadvantage in practically functioning, they are often combined to be utilized. A popular practice is to utilize the mode of withholding at source on the taxable income, which is suitable for withholding at source such as salaries, interest, dividend, bonuses, royalty and lease of property, at the time of payment and at a fixed tax rate or a flat rate. Then, the taxpayer shall make a tax declaration of all his income at the end, and pay the odds between the tax amount calculated from the declaration and the part withheld at source. The revised Individual Income Tax Law gives priority to the mode of withholding at source, and provides the mode of tax declaration as an auxiliary measure. That is in accordance with the national conditions. Since the civil conscience of taxation is still weak and the public awareness of tax declaration is yet to be nurtured, it is a more practicable way to mainly utilize the mode of withholding at source. But according to the international practice, to turn the mode of withholding at source into a mode based or mainly based on tax declaration has its reasonable basis. At least it can nurture the civil conscience of taxation.

       Besides, a tax inspection shall be systematically carried out. American taxation number System[7] is a referable method to strengthen tax source control and to block tax evasion. To set up a system of Individual Economic Identity Card of China will ensure any individual income and expense achieved under such an IEID. At the meantime, to popularize the use of credit card and individual check instead of cash and to use a real-named bank deposit system will enhance the transparency of individual income. The taxation authorities will effectively take the citizen’s income under inspection by a computerized network. With such strict inspection, the civil conscience of taxation will be well nurtured and tax avoidance blocked.