Source: South China Morning Post

Small ChangeTwo news items that recently came out of China caught the attention of the Western media: one serious and the other less so. But both illuminate the degree to which rising inequality has become a top political issue.

The first story was that the Chinese State Council has proposed revising the income tax rates to reduce the tax burden on the working class while raising it for the well-to-do. That is definitely a noteworthy development. The second story, as reported in The New York Times, was that in some localities, the government has limited the size of tombs so that the wealthy would not build ostentatious resting places for their relatives or themselves - and upset the public.

For those well-versed in the intricacies of China's fiscal policy, reforming income tax rates is long overdue but may not be the most effective treatment for China's rising income inequality. And for the cynical observers of local governance in China, keeping the height of tombstones under one metre sounds like a great public relations stunt, but it is no substitute for real policy in tackling the underlying causes of growing inequality.

As in many other transition economies, a variety of factors drive income inequality in China. But revising the income tax rates in a relatively minor way (by raising the tax-exempt income amount from 2,000 yuan - about HK$2,400 - to 3,000 yuan a month) is unlikely to make much of a difference. Overall, China's tax system is regressive. Value-added tax and domestic consumption tax (both viewed as regressive) accounted for roughly one-third of total tax revenue last year. In addition, regressive payroll taxes (such as social security contributions) equal 2.5 per cent of total wage incomes. As a share of tax revenue, personal income tax last year amounted to only 5.8 per cent of total revenue. So it is hardly a potent mechanism for redistribution.

Based on international experience, collecting income taxes in developing economies is costly, inefficient and difficult, mainly because of the preferred use of cash in commercial transactions, poor record-keeping practices and the prevalence of the informal sector. Mainland China is no exception. So even if the proposed income tax reform were to be more dramatic and progressive, it may not generate the desired results.

Beijing should consider additional measures to reduce income inequality.

First, it needs to implement policies that will increase the wage income for Chinese workers. In the past decade, wage growth in mainland China has consistently lagged behind growth in gross domestic product. The relative share of wages as a percentage of GDP has fallen, by using provincial GDP income data, from 53.3 per cent in 1990 to 39.7 per cent in 2007. The relative decline of wages both hinders domestic consumption growth and adds to income inequality (as Chinese workers become relatively worse off).

Raising wages would require giving workers more bargaining power with their employees, protecting labour rights and investing in human capital. Such measures have been proposed, but real progress has yet to occur.

Second, turning China's increasingly divided society into a genuinely harmonious society requires real redistribution of wealth, not just income. Based on sociological surveys, the inequality of wealth distribution is significantly worse than the inequality of income distribution. Remedying this problem is technically and economically feasible.

The Chinese state is perhaps the world's richest sovereign. It owns trillions of dollars in industrial assets and foreign exchange reserves. Distributing some of its wealth to the ordinary Chinese people would have an instantaneous effect on reducing inequality in China and propelling it towards an "ownership society". Hypothetically, cutting China's mammoth foreign exchange reserves by half could deliver US$1,000 to each Chinese individual (equal to a quarter of a Chinese citizen's annual per capita income).

Third, fighting corruption should be another complementary measure. Although the precise effects of corruption on income inequality are hard to measure, survey data in China shows that, politically, the public closely connects corruption with inequality. Economically, a pioneering research project by Wang Xiaolu, an economist at the China Reform Foundation, reports that "grey income" in China could be as high as 9.3 trillion yuan (roughly a third of GDP), and that the top 10 per cent of the households earn 51.9 per cent of the total income. Admittedly, combating corruption is a long-term and politically difficult task. But, even here, there are low-hanging fruits. For example, implementing and enforcing strict wealth disclosure rules on Chinese officials can be a step in the right direction.

The stakes are high as to whether China can slow, if not reverse, the alarming growth of inequality over the past three decades. Besides causing social tensions, inequality itself can impede sustainable economic development. At the moment, Chinese leaders are obsessed with how to avoid the so-called "middle-income trap" (a term referring to stagnant growth for countries with a per capita income of between US$3,000 and US$10,000). Studies of the middle-income trap in Latin America often blame high inequality as a major cause.

So for China, the renewed attention to - and proposed reform for - addressing inequality could not have come at a more opportune time.