By Shi Weigan

Officials from the State Administration of Taxation have been quoted in the media as saying that the country's export tax rebate policy would soon be comprehensively modified.

To curb the export of products consuming massive amounts of energy and resources, and causing large amounts of pollution, the authorities will probably cut tax rebates for the textile, iron and steel, light and metallurgical industries.

At the same time, other sectors may see higher export tax rebates in order to encourage exports of high-tech products.

Measured as a whole, the export tax rebate rate will be cut after this adjustment.

Although government departments have been considering a revision of the export tax rebate system for a year, the latest news about the adjustment still came as a shock to some sectors.

Export and investment have been the two engines driving China's impressive economic growth in recent years.

The government established the export tax rebate system in 1985 to encourage exports. And it has certainly proved to be a strong incentive to exporters.

Textile manufacturers would probably be the first group of exporters to feel the chill after the government cuts the rebates.

Due to redundant production capacity, trade barriers and the appreciation of renminbi, textile manufacturers in Guangdong, Zhejiang and Fujian provinces have been engaged in cut-throat competition and repeatedly slashed their prices

As a result, many of them could only manage profits of 3 to 5 percent after getting a tax rebate of about 10 percent.

Apart from the textile industry, which employs around 10 million people, other industries would be affected by a cut in rebates. They would need quite some time to adapt to this change.

An adjustment of the export tax rebate system would have far-reaching consequences for the entire Chinese economy.

Returning part of the export tax to domestic exporters ensures greater fairness in international trade and avoids double taxation, which is in the spirit of World Trade Organization agreements.

Practically speaking, the rebate system is an important way for the government to promote exports. This system has played a key role in improving the competitive edge of China's commodities on the international market.

But the system has come under criticism in recent years due to a number of defects.

Given the State's limited financial resources, most exporters have to wait for over a year to get their tax refunds. As the nation's export volume grows every year, the increasing number of tax refunds has become a heavy burden for the government.

Offering financial incentives to domestic exporters, the export tax rebate system lifts the profitability of the export-oriented businesses. But it offers no similar support to businesses in other sectors.

Under the system, exporters with higher export volume get more refunds.

With over 90 percent of the country's exporters, the relatively prosperous areas of eastern and southern China have benefited most from these refunds.

Such a fact is already worsening the already great regional disparity.

What is most significant about these defects is that they distort resource allocation in the economy.

The competitiveness of China's exports is mostly based on the low cost of labour and natural resources.

Low labour costs are a result of the nation's massive population, while local natural resource costs are a result of State intervention.

For a number of reasons, the price of resources such as coal, petroleum and agricultural produce remains lower than it would after total marketization.

These low prices are in the national interest as long as China relies heavily on exports for its economic growth.

However, things change when the country has to purchase higher-priced resources on the international market.

When Chinese businesses export products manufactured with higher-priced resources purchased overseas, they can still make profits as long as the government refunds their export tax.

In this way, the State shoulders the burden of the high costs of these imported resources.

Therefore, a change in the export tax rebate system, especially a cut in rebates for resource-intensive industries, could alter the situation.

Modification of the export tax rebate system would improve the efficiency of resource allocation in the economy.

It would also help promote the country's exports in the long term. If the State could cash its promised tax refund sooner, businesses would have a much better circulation of capital.

More technology-intensive products would be exported instead of the energy- or resource-intensive commodities.

A more important job is to study how to make full use of the export tax rebate system to upgrade the country's industrial structure and include more commodities with high added value into the country's export portfolio.

Note: the author is a PhD degree holder from the Institute of World Economics and Politics under Chinese Academy of Social Sciences.

(China Daily June 28, 2006)