Redistributive Impacts of Personal Income Tax in Urban China
The purpose of this paper is to evaluate the redistributive effects of the personal income tax (PIT). Information on the PIT reported in the household survey substantially understates the real tax liability borne by households. The redistributive effects of the personal income tax would be undervalued if the information was used. In order to correct the underestimation of the PIT by non-reporting in our dataset, we apply the tax schedule and impute the tax liability for the individuals in our sample according to the components of their earned income. This imputed tax liability is used to calculate the MT index, the most commonly used measure of the redistributive effects of taxes and governmental subsidies, and to decompose the MT index into the effects of horizontal equity and vertical equity. The MT index and its decomposition show that the personal income tax does reduce inequality, but the effect is small and negligible. The low average personal income tax rate is the main reason why it fails to contribute more to improving inequality.
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