China should adjust its tax policies on income from interest on personal savings to protect small and medium depositors, experts said recently.

Zhang Peisen, Taxation Research Institute senior researcher at the State Administration of Taxation, said the tax policy does not properly take account of the country's present macroeconomic situation.

"The 20 percent tax rate on earnings from interest reduces the purchasing power of medium and low income residents who must bear increasing inflationary pressure amid the country's fast growing economy," he said.

Many are still suffering from negative interest rates, despite the People's Bank of China, the central bank, raising the benchmark rate on one-year deposits by 0.27 percentage points late last month.

According to the National Bureau of Statistics, China's consumer price index (CPI), policy-makers' key inflation gauge, rose 4.1 percent during the first 10 months of this year compared to 2003.

But the benchmark rate on one-year deposits stands at 2.25 percent after the recent interest rate hike -- the first increase in nearly a decade.

"If China's CPI rose to more than 5 percent, which means the country might start to face high-level inflation, it would have a big impact on ordinary residents' consumption behavior," Zhang said.

The country's CPI rose to 5.3 percent in July and August before slowing to 4.3 percent in October.

Higher prices for food and utilities such as water and natural gas have begun to put increasing pressure on medium and low-income families.

The government should adjust the tax policy on interest in a timely way, in coordination with the recent adjustments in interest rates, Zhang said.

"Smooth coordination between monetary policy and fiscal policy is important for China to establish a market-oriented economy," he said.

The government could choose to call off the tax policy, or reduce the tax rate, or set a threshold for such taxation, to protect the interests of medium and low-income depositors, he said.

Qi Jingmei, a senior economist with the State Information Center, agreed there was a need to adjust the tax policy.

"The tax failed to meet its original goal to stimulate investment and consumption," Qi said.

A lack of investment channels has curbed the use of private money, she said. "People still put their money in bank accounts."

Although the country imposed the tax on interest and has cut interest rates eight times since 1996, the growth of consumption was far less than those of bank deposits, she said.

Weak consumption was mainly due to low expectations for income growth, Qi said.

An unsound social security system has forced most to deposit money in banks for future expenditure on housing, medical treatment and their children's education, she said.

For most, especially laid-off workers and farmers, interest rate earnings have become an important source of income.

However, Qi said recent increases minimize the possibility of any changes in the tax policy. "The rate hike is more symbolic than actual," she said, more of a signal that the central bank might further raise them.

The government has seldom before used both monetary policy and fiscal policy simultaneously to adjust the economy, Qi said.

Xie Fuzhan, deputy director of the State Council's Development Research Center, said early this month that interest rates still need to be adjusted, because interest rates are lower than the CPI rise, but the government needs time to observe the impact of recent rate hikes before taking new action.

Ni Hongri, a senior researcher with the center, agreed that pressure on tax policy adjustment was alleviated after the recent rate hike.

The CPI is also expected to drop in the fourth quarter. Meanwhile, fiscal revenues are still not enough to meet expenditure demands. "The government is unlikely to give up the tax," she said, adding that a perfect tax system also needs such tax variety.

(China Daily November 15, 2004)