China Must Solve Urban-Rural Divide to Solve Income Inequality

On Sept. 20, the International Monetary Fund painted a stark portrait of income inequality in China, with officials writing in a blog post that “More than two decades of spectacular economic growth in China have raised incomes dramatically and lifted millions of people out of poverty. But growth hasn’t benefited all segments of the population equally. In fact, China has moved from being moderately unequal in 1990 to being one of the world’s most unequal countries.”

The IMF’s statistics show that the post-tax, post-transfer Gini Index – with 0 indicating absolute equal income distribution while 100 indicates total unequal income distribution – has risen by about 15 points since 1990 to hit about 50 of the 100 scale in 2015.

That surge makes China stand out in two regards. First, the indicator is calculated after taxes and transfers – meaning it represents the income distribution of the country after everything the government has done to try to narrow the gap between rich and poor, haves and have-nots. Second, the unrelenting rise in income inequality in China outpaces the average of five ASEAN countries – Indonesia, Malaysia, Philippines, Singapore and Thailand – as well as the average for the OECD, comprising 36 countries including many of the world’s most advanced countries but also emerging countries like Mexico, Chile and Turkey.

The IMF attributes a significant part of the rise in income inequality in China to its urban-rural divide, which for example is exhibited in lower educational attainment in the rural areas. One inference flowing from such a result might be that the rural areas won’t benefit as much from an increase in jobs that require higher skills even though such changes in labor market opportunities are made accessible for those in the rural areas.

As indicated in the OECD’s 2017 economic survey of China, income inequality in the rural areas in China is consistently higher than that in the urban areas. This oft-neglected aspect of the rural-urban divide can be illustrated by comparing the ratio of disposable income of the top 20 percent over that of the bottom 20 percent of the rural areas against the same ratio of the urban areas. The higher the ratio goes, the more income inequality there is.

In 2005 and 2010, the ratio was higher than 7 in rural areas but lower than 6 in urban areas. In 2015, the ratio rose to over 8 in the rural areas and fell to slightly above 5 in the urban areas. One interpretation is that not only is income inequality a bigger problem in the rural areas than in the urban areas but the problem is also getting bigger and bigger.

To shrink the growing gulf between rich and the poor, China thus needs not only more progressive tax and transfer policies but also policies that can significantly alter the urban-rural dynamics. Despite Beijing’s apparent efforts to slow the rise in income inequality by raising the minimum wage along with the minimum threshold for income taxes, the IMF warned “inequality is likely to rise further without additional policy changes.”

One idea the IMF floated in the blog post is to make the tax and transfer system more progressive, i.e. those who earn more and have more will be asked to pay more. “China could rely more on the personal income tax and less on regressive consumption taxes,” the IMF notes. “The design of personal income taxes and social security taxes could be made more progressive. And there is also room to further increase spending on social services, especially in rural areas, reducing inequality even more.”

The OECD, in discussing measures to generate more tax revenues in its 2017 economic survey of China, has offered a glimpse of what can be done: “Potential sources of revenue include a more progressive personal income tax, and more comprehensive taxation of income beyond wages (including rent and other types of income) as well as a recurrent tax on immovable property and an inheritance tax. There is also ample room to raise environmental taxes. A fairer tax system would help reduce income and wealth inequalities and make growth more inclusive”.

The big picture is clear. Based on what the IMF and the OECD say, if China wants to tackle income inequality, a more progressive tax-and-transfer system will be needed – more tax revenue will need to be raised, and the revenue will need to be used to fund more expenditures to bolster social protection. As shown by the Asian Development Bank, China’s social protection expenditures have been hovering around 5 percent of GDP since 2008 and rose to 6.5 percent in 2012, only to fall back to 4.2 percent in 2013.

The income inequality fix seems straightforward but no doubt it’s easier said than done. Those who live in China’s megacities in contrast with those living in small rural villages appear to be living in parallel universes. In order to take on the urban-rural divide, how about tax the rich in the urban areas a lot more and at the same time spend on the poor in the rural areas a lot more? That would make the tax-and-transfer system more progressive, but to start with, any change to China’s tax system would draw criticism. Some would consider any tax cut as too timid while others would consider any tax increase too risky.

But even if the barriers of inertia to fiscal policy changes could be overcome, are all obstacles blocking China’s possible very long march toward less income inequality cleared? How to figure that out anyway?

If an unprecedented bridging of the urban-rural divide could be done, there might be hope for economic justice. However, it’s a long and winding road to even just develop substantial longitudinal data to explore a topic like this further. To illustrate the point, this is how researchers including Thomas Piketty talked about the needs for reliable data about China: “An income tax has been in place since 1980, but until recently no detailed tax statistics were available, so that scholars had to rely on household surveys based upon self-reported information.”

They have embarked on this journey to develop useful data for informative analysis. But given the starting point there will be such a daunting amount of work to be done, not the same but in spirit analogous to tackling the urban-rural divide in China.

Thaddeus Hwong is an Associate Professor at York University, Canada. Hwong (@policyquests) aspires to contribute to our understanding of advocacy and mobilization for redistribution through progressive taxation and public expenditures.