Source: forbes.com



This article is by Shaun Rein, whose book The End of Cheap China: Economic and Cultural Trends That Will Disrupt the World will be published in the spring. He is the founder and managing director of the China Market Research Group.


According to data compiled by the Central Intelligence Agency, the United States has worse income inequality than China or Iran. The economic status quo in America is broken, and it needs to be fixed or the country could become a banana republic. President Obama needs to increase the assets of America’s lower classes while curtailing runaway wealth. Although income inequality remains a serious problem in China, too, President Obama should look to that country for lessons on how to fix America’s tax code. Some of what China has done to minimize economic disparity is working.

The president should learn from China to shift some of the tax burden from lower income classes to wealthier people by increasing taxes on consumption rather than, as he has tried to do, on income. High income taxes don’t work. They sap the incentive to work hard and create new businesses, as critics have rightly pointed out. No president should put up boundaries to working hard and creating businesses, and thus to job creation.

The president’s definition of the wealthy as being households with incomes above $250,000 is not realistic today. Even raising the limit to $1 million, or focusing on taxing the incomes of the ultra rich, as the billionaire Warren Buffett has wanted to do, would not work, for the revenue raised would be offset by people working and investing less. Nonetheless, in desperate times (and don’t let anyone kid you, we are in desperate times), taxes need to be raised on those who can afford it, by focusing on taxing consumption in targeted areas like luxury homes and autos. Even President Reagan raised taxes 11 times during his administration. In fact, he raised taxes in seven of his eight years as president.

To help reduce the burden on China’s poor, the Chinese government has increased taxes for buyers of expensive and large homes and introduced a transfer tax for people who sell homes quickly. The country also has high taxes on luxury cars like BMWs and Mercedes, and even watches and pens. Despite those high taxes, sales for luxury cars in China soared 30% in 2011, my firm estimates. Sales are so strong that Porsche expects China to eclipse America as its largest market in the next three years.

Partially because of those high consumption taxes, prices for luxury cars are often two or three times as much as in America. For instance, an S600 Mercedes runs about $350,000 in China, versus $120,000 in America. Even a souped-up Toyota Camry costs as much in China as an entry-level Porsche in America. The soaring sales of luxury cars there prove that the wealthy will continue to consume despite a high consumption tax, which won’t destroy confidence the way high incomes taxes would.

By taxing consumption more, the Chinese government has been able to reduce income taxes for low and middle income earners while leaving income taxes for high earners untouched. In October of 2011, the government raised the minimum taxable wage level by about 10%, immediately enlarging the spending power of millions. Most Chinese now don’t pay any income tax. The government also reduced tax rates for small enterprises while maintaining tax rates for larger corporations, including state-owned enterprises.

The government also has increased minimum wages. In 2011, 21 of China’s 31 provinces increased the minimum wage, by an average of 22%. Higher wages have dented corporate profits, but many companies have been taking advantage of their workers for far too long. For instance, in response to worker unrest last year, Foxconn, the maker of many of Apple and Dell products, increased its average wage by 66%, yet it’s still expanding its China-based operations. In the U.S., a new minimum wage bill was last passed in 2007, forcing adoption of a minimum wage of $7.25 by July 24, 2009. An annual income at that rate would be just above $15,000, while the Federal government defines the poverty line as an annual salary of $22,350 for a family of four.

By raising consumption taxes on products and services targeting the affluent while reducing or maintaining income tax levels, the Chinese government has been able to sustain consumer confidence, increase spending (retail sales have risen 16-18% annually over the last three years), and get needed tax revenue for infrastructure projects required to maintain employment numbers. China has not cracked the income disparity problem, but its measures to reduce inequality have been more effective than America’s and have not polarized the nation.