The Middle Kingdom Runs Dry: Tax Evasion in China

China watchers regularly warn that a raft of well-known problems besets the Middle Kingdom. These usual suspects include a ballooning population, environmental degradation, growing ethnic tensions, and uncomfortable relations with China's neighbors. But the country has an even more immediate problem that has until now received far too little attention: Beijing can barely collect its taxes. At a time when China's economic growth rate is slowing and its thirst for public funds is growing, this chronic inability to collect taxes has all but crippled the government. And so far, all efforts to address the problem have failed.

Throughout the 1990s, successive crackdowns on tax evaders were launched to little avail. Government income as a share of gross domestic product (GDP) continued to decline throughout the decade, sinking to 12 percent in 1998 from 32 percent in 1978 -- a rate lower than those of the world's most laissez-faire economic regimes. At the same time, individual income as a proportion of GDP increased from 49 to 61 percent.

Understanding China's desperate thirst for cash is not difficult. It owes in large part to the enormous losses regularly suffered by the noncompetitive state-owned enterprises (SOES) that employ most of the workers in urban China. These hemorrhaging businesses must be bailed out by loans from state banks that then become insolvent themselves, requiring recapitalization and extending the economic crisis down the line. Workers laid off by those SOES not kept on life support by the banks also require government support. At the same time, Beijing is spending huge amounts on economic stimulus packages to prop up its GDP. The government also keeps expanding defense budgets to compensate the armed forces for the recent loss of their commercial businesses, which Beijing stripped from them in an attempt to reduce the military's power.