China is supposed to complete the conversion of business tax (“BT”) to value-added-tax (“VAT”) as required by the 13th Five-year Plan (“13.5”) approved by the 12th National People’s Congress on March 16, 2016.

According to news report by Xinhua Agency (i.e. the official news agency of China, http://www.gov.cn/xinwen/2016-04/13/content_5063569.htm) on April 13, 2016, the complete conversion will result in a total tax reduction value RMB 500 billion in China in 2016. It is expressly promised by Premier Li Keqiang that in all related industries, the tax burden shall only decrease instead of increase due to this BT-VAT conversion. Seems to be something to cheer about? – Hmmm, maybe not yet. You may want to check out the possible reactions of local governments before cheering up for the tax reduction. Why? Because the interests of central government may not always be consistent with that of local governments (e.g. province, county, town to village level).

1. BT is local government’s money

According to Decision of the State Council on Implementation of Tax Sharing Administration System promulgated on December 15, 1993 (“Tax-Sharing Decision”), since January 1, 1994, BT shall be the income of local government, while VAT shall be shared by center government (by 75%) and local government (by 25%).

Thanks to this Tax-Sharing Decision, the income proportion between central government and local governments has dramatically changed as shown below: from a starving central government to a very powerful central government (Unless otherwise specified, all the charts in this article are automatically produced with the tools and figures from National Data of the PRC National Bureau of Statistics (“Statistics Bureau”)).

If the sharing rate won’t change (there promised to be a change at least in transition period in the 13.5, however no details yet), converting BT to VAT means the central government will further grab 3/4 of the biggest piece of cake from the local government’s plate (see blue section).

If you were the local governor, will you sit still and let go?

Probably yes, some would say, if that means less work. Well then let’s read the below section.

2. More work with less money?

From 1992 until now (the proportion figures of 2014-2015 are not provided by Statistic Bureau), the local governments have borne major parts of the expenditures – it also reflects that majority of the work were actually carried out by local government.

Since 1994, along with the trend to concentrate money upward, there is also a tendency to push tasks/duties/expenditure obligations downward (as shown in above chart) (See examples of news and commentaries: http://www.chinanews.com/gn/news/2009/11-16/1966166.shtml; http://www.cb.com.cn/economy/2013_0907/1012014.html; http://finance.eastmoney.com/news/1350,20130908321235077.html; http://www.firstacc.cn/news/200911/2052.html). Such two trends are crushing the local level governments, especially the bottom level which bear the most implementation tasks while with least financial support or power.

The police “simplification and delegation” (in Chinese 简政放权) provided in 13.5 may impact on such trend – but the thing is – to which direction?

Simplification may result in less work, however delegation will increase the work of local governments. We have seen such complaints from news (http://finance.jrj.com.cn/people/2015/03/11083718946299.shtml; http://theory.people.com.cn/n/2015/0806/c207270-27419766.html; http://bbs1.people.com.cn/post/2/2/1/137245987.html).

3. Get financed somewhere else

When the central government is squeezing money from local governments, and pushing more tasks to local governments, the only reasonable solution for local governments seem to be get financed in other way.

Therefore, one may expect the following changes so as to get local government financed:

a. Increasing direct tax (provided under 13.5)

E.g. IIT, consumption tax, resources using tax (to be charged according to value), real estate tax, environmental protection tax as mentioned or implied in 13.5.

However among the direct tax, the income tax of enterprise may not rise since it is conflicting with the policy of “reducing burden of enterprises”.

As a pre-condition of such shifting of taxation from enterprises to individuals, the information collection on individual (income, assets etc.) will be established, which we have seen such legislation in recent years.

b. Squeezing more profit from State-owned enterprises (“SOE”)

As provided in 13.5, the State will gradually increase the proportions of profits to be collected from investment of State-owned capital. According to the Decisions on Several Key Questions on Comprehensively Deepening Reform (in Chinese中共中央关于全面深化改革若干重大问题的决定) issued by the central committee of China Communist Party on November 12, 2013 (i.e. the master plan behind 13.5), by 2020, the proportions shall be raised to 30%.

Such squeezing may lead to chain reactions of SOEs. One may expect the SOEs to push for more profit in business so as to make up the lost part.

c. Other options?

Local governmental debts, selling land use right, severer fines (e.g. recently draft revision to PRCAnti-Unfair Competition Law has substantially increased the fine applicable to incompliance acts).

4. Summary

In general, the logic behind 13.5 is to reduce burden on enterprises. However due to the unbalanced tax and duty distribution system between central government and local government, what has been granted by the central government may be (partly) offset by local government in certain form. For the same reason, the burden on individuals may increase.