Chinese tax breaks

Bankers' heaven

A lesson in regressive taxation

Mar 31st 2010 | SHANGHAI | From The Economist print edition

AS AMERICA and Europe plan new ways to claw back money from high earners in finance, China is going the other way. When the Communist Party decided to transform Shanghai into a financial centre, it gave a great deal of thought to personal-tax incentives. A ruling put out at the end of 2008 by the city’s Pudong district is the most regressive form of taxation imaginable.

Ordinarily, China imposes one of the highest top marginal income-tax rates in the world, 45%. There are few complaints about this from locals: nothing good is likely to come from provoking the authorities’ attention. But it is a turn-off for employees of companies that Shanghai wants to attract to the skyscrapers popping up on the western bank of the Huangpu River.

Chinese law specifically bans local governments from offering personal tax breaks, but there is a way around this constraint. Typically taxes are divided into two pools, with 60% going to the national government in Beijing and the remaining 40% retained locally. The most competitive local governments collect their share and then send it straight back to the lucky taxpayer—technically a reimbursement, but in reality a big tax break.

The ruling by Pudong’s district government—Circular 301, as it is officially called—allows these subsidies to be paid to “qualified financial talents working at qualified financial institutions”. Upon approval by regulators, senior managers can receive a reimbursement of 40% of their taxes, plus a housing subsidy. That pushes their tax rate down to 27%, still higher than Hong Kong’s 15% and Singapore’s 20% but well below what a banker would pay in New York (44%) or London (soon to be 50%) or for that matter Tokyo (50%) or Seoul (35%).

Bankers who are not quite so important get a not-so-grand tax break, roughly half as large. More junior staff get nothing. The same system of targeted personal-tax breaks for senior executives was apparently successfully used in Beijing to entice financial firms to move from one side of the Forbidden City to the other, to an area called Financial Street. Once the leading global firms had moved their offices, the tax rebates were allowed to lapse. The same will probably happen in Shanghai. But for now, if you’re a capitalist-roader, the people’s party is pretty hard to beat.