A larger-than-expected fiscal surplus in 2004 has shored up China's efforts to unify corporate income tax for domestic and foreign-funded businesses.

But opposition to the tax reform remains strong.

To push ahead with this critical reform, the Chinese authorities must come up with a clear timetable to dispel suspicion on the country's policy certainty.

Mainly thanks to the rapid growth of the national economy, the country's tax revenue, exclusive of tariffs and agriculture tax, reached 2.57 trillion yuan (US$310 billion) in 2004, up 25.7 per cent over the previous year. Robust growth in tax revenue brought about a fiscal surplus of 284 billion yuan (US$34 billion) between January and November last year.

A remarkable feat. Just a year ago, China's fiscal deficit still stood at 293.4 billion yuan (US$35.78 billion).

Now, the unexpected fiscal surplus not only enables the central government to clear all the export tax rebates it was in arrears with, but also encourages quite a number of local governments to scrap agricultural tax three years ahead of schedule.

The former move helps lift a chronic drain on the country's public coffers. The latter relieves farmers of tax burdens.

Yet by emboldening tax and financial officials to take on split corporate income taxes, one of the most important results of the unusual fiscal trade surplus may just be unfolding.

Early this month, three top officials from the State Administration of Taxation and the Ministry of Finance vowed to step up preparations for unification of the dual-track income tax policies for domestic and foreign-funded companies.

Such repeated high-profile advocacy ostensibly aims to drive home a sense of urgency on this belated tax reform.

Currently, foreign-funded companies enjoy a nominal income tax rate of 15 per cent, while domestic firms have to pay 33 per cent of their income in tax. Though the actual income tax burden on the two types of businesses may not differ as much as the nominal income tax rates indicate, many believe this tax gap alone has already mounted to a disadvantage domestic players can hardly afford in the face of intensified competition.

In retrospect, the de facto favourable treatment for foreign investors was a natural result of the country's reform and opening-up policy adopted quarter of a century ago.

To attract foreign investment to quench the Chinese economy's thirst for funds, technology and management, the favourable taxation terms the country offered at that time were both reasonable and necessary.

Such preferential tax policies had set China on course for sustained growth in utilization of foreign direct investment. By last September, the country's aggregate contracted foreign direct investment had exceeded US$1 trillion.

Radical market-oriented reforms and long-term economic growth have turned China into a top destination for foreign investment. Last year, the country registered a record actual foreign direct investment of US$60.6 billion.

But as the country keeps dismantling domestic barriers in line with its commitments to the World Trade Organization, such preferential tax policies for foreign companies seem increasingly outdated as well as outrageous.

Clearly, it cannot just sell to create a level playing field for multinationals in the domestic market at the expense of heavier income tax for domestic enterprises.

A unified tax code is badly needed to put domestic businesses on an equal footing in competition with multinationals.

The reasons why top tax and financial policy-makers have recently made louder calls for corporate income tax reform are not hard to discern.

On the one hand, last year's big fiscal surplus has financially equipped these policy-makers for the tax reform.

It is reported that the unified income tax rate for both domestic and foreign-funded companies will be fixed at a level between the current nominal rates of 33 per cent and 15 per cent. Preferential tax policies will be granted by region and industry according to the country's development strategy.

Since the new tax rate is more likely to be near the lower level and domestic companies constitute most of the tax base, the amount of corporate income tax collected will decrease after unification.

The cost of such a reform will be dear.

But the huge fiscal surplus and the growth momentum of the country's tax revenue have convinced tax and financial authorities that they can afford it.

On the other hand, it is the ever expanding cost of the tax reform that presses the policy-makers into action.

As the Chinese economy has grown by about 9 per cent a year in recent years, the country's tax revenue has rocketed at a double-digit rate. That means any delay to unify the different corporate income taxes will only make this reform even more expensive.

Thus, from a fiscal point of view, top tax and financial officials' recent calls for a simpler tax code may seem to make perfect sense.

But there are many who do not buy it.

No surprise that multinationals will groan. The new unified corporate income tax, more or less, will bite into foreign-funded companies' profits.

It is unjustifiable for them to take for granted the preferential tax policies they have enjoyed for many years and demand more and more national treatment.

Yet, their complaints about the uncertainty concerning tax policies does merit the Chinese authorities' attention.

If a simpler tax code is to spur more economic growth, related policies must be made predictable to allow businesses from home and abroad to make informed investment decisions.

Some local governments and the Ministry of Commerce have also reportedly objected against the tax reform for fear of daunting foreign investors.

Given the huge contribution foreign investment made to the development of many local economies and the country's trading sector, these domestic worries are fairly understandable.

But that does not give them a blanket excuse for trying to postpone the needed reform.

The tax reform is a problem of when rather than a problem of if.

The long-term benefit to the Chinese economy from a simpler and fairer tax system will far outweigh the short-term opposition that it will provoke.

The tax and financial policy-makers' determination to undertake a wholesale review of the tax system and fix those loopholes, in the longer term, will pay dividends.

Even if they do not want to do it immediately, the policy-makers must set out a clear timetable for unification of corporate income tax.

After all, a clear-cut plan, by itself, will lend much credit to the tax reform.

(China Daily January 27, 2005)