DP5703 | Income Inequality and Progressive Income Taxation in China and India, 1986-2015

Publication Date

30/05/2006

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Abstract

This paper evaluates the prospects for income tax reform in China during the coming decade (with a comparison to India), and argues that such reforms should rank high on the policy agenda in these two countries. Due to high average income growth and sharply rising top income shares during the 1990s and early 2000s, progressive income taxation is about to raise non-trivial tax revenues in China and India and to become an important political object. According to our projections, the income tax should raise at least 4% of Chinese GDP in 2010 (versus less than 1% in 2000 and 0,1% in 1990), in spite of the 20% nominal rise in the exemption threshold that took effect in 2004. The fact that progressive income taxation is becoming an important policy tool has important consequences for China?s ability to finance social spending and to keep under control the rise in income inequality associated to globalization and growth. Due to faster income growth and to a higher fraction of wage earners in the labor force, the prospects for income tax development look better in China than in India. This potential is however limited by the fact that Chinese top wage-earners are under-taxed relatively to top non-wage income earners.