Commentary: China: Jailing Tax Cheats Is Just a Start

The nation's entire legal and regulatory system is flimsy, which greatly hinders the building of a modern economy

By Mark L. Clifford

Maybe getting rich isn't so glorious after all. In fact, in China these days, it's looking downright dangerous. In recent weeks, Chinese authorities have hauled some of the country's wealthiest citizens in for questioning about unspecified "economic crimes"--read tax evasion and corruption--a turn of events that has spurred many of the country's nouveaux riches to leave the Mercedes parked in the garage.

The crackdown isn't necessarily a bad thing: Most wealthy Chinese don't pay anywhere near the legal tax rate, which tops out at 45% on income exceeding $12,000 per month. While most cough up some tax, they typically hide much of their income. "Strictly speaking, all of the private entrepreneurs have tax problems," says a well-off mainland native now based in Hong Kong, where he's less visible to the Chinese authorities. "They say: `If I pay tax, how can I get rich?"'

Granted, China shouldn't put too many obstacles in wealth's path. The country needs the private sector, which provides more than half of its $1.2 trillion gross domestic product. But China's entrepreneurs must also accept that taxation is necessary, and that they must pay their fair share. By singling out a few high-profile individuals, Beijing will likely get the attention of scofflaws.

To really succeed, though, the campaign needs to include a broader legal overhaul. The tax code is just one part of a flimsy legal and regulatory system that threatens China's economic future. After all, it's difficult to have a modern economy when every business is operating in gray areas. Property rights aren't evenly enforced, local officials capriciously grant and revoke licenses, and companies and individuals with good connections get tax breaks, while those with fewer friends or less money for greasing palms have to pay full fare. And often, charges of tax evasion are merely a pretext to ensnare those who have fallen out of favor for some other reason. "It's a shame tax exemptions and sweetheart deals are so common," says UBS Warburg analyst Joe Zhang.

Such unequal treatment creates contempt for the legal system, which in turn corrodes public trust. That's especially dangerous at a time when once-egalitarian China has a widening gap between rich and poor. China will be headed for social disaster if the income gap grows while schools and hospitals deteriorate and workers are squeezed for taxes they are too poor to evade.

It's a good sign that Premier Zhu Rongji himself has kicked off the crusade to collect more taxes. Although the effort may be motivated more by fiscal prudence than by any deep desire to enforce the rule of law, at least it's a step in the right direction. "Zhu wants to find a source of more revenue," says a prominent Hong Kong businessman with close connections to Beijing. "Eventually, everyone will be paying taxes."

Beijing damages its case against tax cheats, though, when it acts in an arbitrary, high-handed way. Take the case of Yang Bin. He's the orchid-grower-turned-real-estate-magnate who rocketed to international prominence in September, when North Korea appointed him to run a special economic zone in Sinuiju, on the Chinese border. Now, two weeks after his detention, Yang hasn't been charged with any crime, although the Foreign Ministry has suggested he is being investigated for his loose interpretation of the tax code.

If Yang has committed a crime, China should charge him swiftly. If not, he should be released immediately. When a government acts justly, its citizens find it easier to part with their money and pay taxes. But when authorities act capriciously, and use the tax code to advance political agendas, then all of China's Yang Bin wannabes will figure they'll never get a fair deal--and just hoard their gains all the more closely.

Hong Kong-based Clifford is Asia regional bureau chief.

Before it's here, it's on the Bloomberg Terminal.