The Middle Kingdom Runs Dry: Tax Evasion in China

William Gamble

From Foreign Affairs, November/December 2000

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Summary:  Thanks to a woefully corrupt and inefficient tax system, Beijing is going broke. China must fix its tax problems fast, before globalization speeds it into bankruptcy.

William Gamble is a lawyer and a principal in Emerging Market Strategies, a forecast and risk management firm specializing in the global marketplace.

China watchers regularly warn that a raft of well-known problems besets the Middle Kingdom. These usual suspects include a ballooning population, environmental degradation, growing ethnic tensions, and uncomfortable relations with China's neighbors. But the country has an even more immediate problem that has until now received far too little attention: Beijing can barely collect its taxes. At a time when China's economic growth rate is slowing and its thirst for public funds is growing, this chronic inability to collect taxes has all but crippled the government. And so far, all efforts to address the problem have failed.

Throughout the 1990s, successive crackdowns on tax evaders were launched to little avail. Government income as a share of gross domestic product (GDP) continued to decline throughout the decade, sinking to 12 percent in 1998 from 32 percent in 1978 -- a rate lower than those of the world's most laissez-faire economic regimes. At the same time, individual income as a proportion of GDP increased from 49 to 61 percent.

Understanding China's desperate thirst for cash is not difficult. It owes in large part to the enormous losses regularly suffered by the noncompetitive state-owned enterprises (SOES) that employ most of the workers in urban China. These hemorrhaging businesses must be bailed out by loans from state banks that then become insolvent themselves, requiring recapitalization and extending the economic crisis down the line. Workers laid off by those SOES not kept on life support by the banks also require government support. At the same time, Beijing is spending huge amounts on economic stimulus packages to prop up its GDP. The government also keeps expanding defense budgets to compensate the armed forces for the recent loss of their commercial businesses, which Beijing stripped from them in an attempt to reduce the military's power.

Yet while expenses are increasing, China's government income has dwindled. Beijing has tried to reverse this dangerous trend by improving the efficiency of its tax system; the latest efforts to alleviate the funding drought have included public executions of tax evaders, upgraded computer systems for the tax bureaucracy, intensified scrutiny of bank transactions, and closure of many loopholes. These measures may increase revenues somewhat, but because of the inefficiencies inherent in a centrally planned economy, they will not stop the decline of government revenues relative to GDP.

Part of the problem lies with the modern structure of China's government. In the early stages of China's communist development, economic, political, and legal power was concentrated in the government's hands, and this seemed to work -- at least at first. But the overwhelming power of the central government devolved over time to local officials and, especially, to managers of large enterprises. These managers also assumed the duties of landlord, mayor, fire chief, and even school principal.

These same local managers and government officials now collude for their own personal interests, those of their enterprise or industry, and those of their locality -- but not those of Beijing. The result is that Beijing gets ...

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