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Tax incentives have contributed enormously to the rise of China’s economy. Although they have experienced fluctuations since the “reform and opening‑up” policy in 1978, with the country tailoring its tax incentives to create a level playing field in the market – especially after accession to the World Trade Organization (WTO) – China still has a state‑oriented attitude towards the granting of tax incentives. This attitude tends to treat tax incentives as instruments to achieve policy goals, but they often lack the necessary legal control.

The evolution of tax incentives in China demonstrates that the Chinese Government has realised the importance of integrating into the world economy by adapting to the international legal standards. However, it has not established an internal legal assessment system with regard to tax incentives, nor a legal remedy system, particularly for harm caused by tax incentives. Moreover, there is no consensus in China to restrict the use of tax incentives, as is the case in the West.

China’s state-oriented attitude towards tax incentives and the lack of internal legal control over granting them have their origins, predominantly, in two historical periods: between socialist China (1949 to present) and traditional China (16th century to 1949).

The origin of China’s state-oriented attitude

Socialist China

From 1949 until 1978, China had a planned economy, with no free market. The state had absolute control over taxation. As such, the state only treated taxation as an instrument to achieve its allocation of resources and economic goals. Influenced by Marxism, taxation and law were thus considered part of the superstructure, subordinate to the economy.

Since 1978, China has moved to a market economy, but the state still has control over the economy. State-owned enterprises (SOEs) are leading forces of the economy and receive more tax preferences from the government, which seeks to satisfy their needs, even via unfair tax preferences, to guarantee the stability and prosperity of key national industries.

Traditional China

The concept of the state in traditional China was very different from the West. The state functioned as the emperor’s state, which had to accord with the emperor’s rule first, and formed a highly centralised political system to strengthen the emperor’s and its own power.

Accordingly, with respect to taxation, there was no clear separation between the emperor’s personal income and expenses and the state’s expenditure. In addition, the state had a dominant role in the administration of the economy, by adopting a pro‑agriculture/anti‑commerce policy.

Consequently, there was no comparable development of commerce in China at that time, not to mention the formation of a free market. All these factors contribute to the understanding of China’s current state‑oriented attitude towards a market economy system.

The lack of legal control over the granting of tax incentives

Socialist China

Before the reform and opening‑up policy in 1978, Marxist legal theories had the dominant position. The instrumentalist feature of tax incentives may have resulted from the doctrinal interpretation of Marxism.

At the time, the economy was considered the key element of a production force, while the cultural and institutional factors of the society belonged to the superstructure. It was taken for granted that law, as a part of the superstructure, should play a role that was subordinate to the economy, even as a means to achieve economic ends. Thus, from the beginning, not only taxation, but also the legal system itself had an instrumental function to government.

After the reform and opening‑up and the introduction of a market economy, China gradually adopted the rule of law. The country is going further by establishing a rule of law in more areas of regulation, but it is not likely to be in the same way as the liberal democratic rule of law generally accepted by Western countries. The concept of a “socialist rule of law with Chinese characteristics” clearly does not transplant or copy the Western format, but it will adapt the so‑called “international best practices” to fit its own circumstances.

However, even against the background of establishing a socialist rule of law, there is still a lack of legal control over tax incentives. For instance, no specific law or regulation stipulates the legal procedure for granting tax incentives; there is no law on remedies for tax incentives, especially from the perspective of restricting the government’s power; and there is no law on the allocation of powers between the body granting tax incentives and the supervision body.

Traditional China

Ancient China and Imperial China were under the rule of emperors: although there were codified laws, the role of legislation was simply to serve the emperor governing the country and people. The most influential classical legal theories in ancient China include the Confucian rule by rituals (Li Zhi) and the legalist rule by law (Fa Zhi).[1] Laws were merely used as tools of the rulers to impose punishment and to exercise administration over the people, and even to govern the behaviour of officials.

As a result, the rulers themselves were exempted from the control of the law, because the authority of the law came directly from them. Both of these classical theories had a great influence on the role of law in each dynasty of Imperial China. Despite their different premises, they have one common feature, and that is to serve the ruling of the ruler.

Cultural influences: Confucianism

By advocating humanity and self-cultivation through virtue and ritual, Confucianism supported a highly organised government under the ruler in traditional China. Although Confucianism was modernised in socialist China, its revival was still oriented by the government with the purpose of maintaining a harmonious social order. Moreover, the philosophies of Confucianism underline adaption and adjustment to the environment and the world, rather than heading against them. It contributes to the understanding of the formation of a paternalistic government in China.

Implications

Western countries including Australia need to better understand the rationale behind China’s state‑oriented attitude towards tax incentives, namely, the detailed reasons for the differences, so they could take action to seek common ground for cooperation, instead of resorting to trade disputes.

China is Australia’s largest trading partner in terms of both imports and exports. The China–Australia Free Trade Agreement entered into force in 2015, with the goal of benefitting from bilateral investment and trade and to avoid possible conflicts.

Economic relationships are in flux, so there is no one‑size‑fits‑all model. China obviously has to bring some form of legal control over its granting of tax incentives, but the West also has to understand that it is not realistic to expect China to have a liberal democratic attitude towards them.

Conclusion

China has undertaken a different path to the West regarding its market economy and the rule of law, which has shaped its attitude towards the granting of tax incentives.

Considering China’s current economic slowdown, it is necessary for the country to pursue more opportunities in the international market, which requires establishing mechanisms to ensure fair competition in China’s domestic market and China’s fair participation in the international market. Therefore, under China’s market system, the creation of fair competition should also be an objective in order to increase efficiency. Bringing the granting of tax incentives into a more legally regulated system will help to achieve the goal of establishing the socialist rule of law in China.

For the West, by understanding the reasons behind China’s state‑oriented attitude towards tax incentives, they can better position themselves in their interactions with the country, especially in the area of investment and trade. To seek common ground is the best way to avoid conflicts with China.

 

For the full article, see Xu, D 2018, ‘Why does China have a state-oriented attitude towards tax incentives?’, Australian Tax Forum, Vol. 33, No. 4, pp. 805-825.

[1] Li Zhi and Fa Zhi are Chinese pinyin. Rule by rituals emphasized ruling by the ruler’s virtue and morality in order to achieve a humane and harmonious society. The legalist rule by law advocated clearly codified laws that were publicly promulgated in order to strengthen the control of the ruler. See Randall Peerenboom, China’s Long March toward Rule of Law, Cambridge University Press, 2002, pp. 65-68.

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