China Flirts with an Estate Tax

October 3, 2013

According to the Wall Street Journal, Communist Party officials in China have started discussing the implementation of an estate tax for China.

“The private 21st Century Business Herald reported on September 27th that the Communist Party’s top decision makers will consider the inheritance tax at the Third Plenum, a key meeting of senior leaders expected in November.”

Supporters of the estate tax in China say that the country needs it to tackle income inequality. According to a Peking University survey, the bottom 25 percent of China’s households accounted for just 3.9 percent of total income, compared with 59 percent for the top 25 percent of earners.

Officials also said that based on international experience, they want to use the tax to boost social programs.

However, many people on China’s Weibo social network were opposed to this tax and for good reason.

It would be unfortunate if China were to enact an estate tax, especially for the two reasons that it stated.

If you look at the United States’ experience with the estate tax, it is likely that a Chinese estate tax would only raise marginal revenue for social programs. People are able to avoid it by changing their behavior (spend instead of save), thus there will be fewer taxable estates and tax revenue. In the United States, the estate tax only raised .42 percent of total federal revenue in 2012; the smallest source of federal revenue.

If funding major social programs were a priority for the Communist Party, a broad-based tax would be more appropriate like a payroll or consumption tax. An estate tax would simply not raise enough revenue.

Introducing the estate tax in China to tackle inequality is also odd. If you look at the experience in the United States, the estate tax doesn’t really reverse income inequality. The reason is that most inequality isn’t caused by inheritance. Research has shown that only 2 percent of inequality in the United States can be accounted for by family members passing on wealth. So would a tax that only touches 2 percent of all inequality really reverse it?

Of course, China isn’t the United States, but it seems like inheritance may play an even smaller role in China since very few families are really wealthy compared to the United States.

And why use such a weak mechanism to fix inequality when there are so many other major policies that are likely contributing more to inequality in China? For one, the Hukou System, an internal immigration regime, regulates the movement of labor from the country to the city. This prevents poor rural farm workers from migrating to cities where there are better opportunities and keeps low-skilled wages very low. In addition, people cannot own land and the government can essentially remove anyone from where they live for the “public good,” especially poor farmers who live in the way of city development. Reversing these policies would likely do a lot more for inequality in China than the estate tax.

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