China’s Rising Social Inequality: Hukuo, Gov’t Decentralization, and Regressive Taxation

To what extent has China’s growth-centric policies worsened the level of social inequality in the urban regions?

China’s decades-long journey to prosperity is not without its dark side. Economic inequality has now reached a point when the Chinese Communist Party (CCP) has finally taken note and has now taken the necessary steps to address the growing issue. In particular, is the issue of social welfare among millions of migrant workers working and living in China’s coastal cities. The reason for this is quite straightforward: the CCP’s continued legitimacy and future survival hinges in its capacity to prevent another Tiananmen Square incident. The obstacles to addressing such a problem, however, requires a major overhaul of the three-decades long economic orthodoxy based on political decentralization (which gave local governments the initiative to mould their economic and social policies to serve the interests of their local population) existing alongside the China’s discriminatory hukuo (household) registration system (which is a discriminatory system that generally favours those with an urban hukuo status at the expense of those with rural status — most of which are migrant workers). These two factors have, in many respects, delivered China’s economic ascendance and the CCP’s longevity. Paradoxically, however, these same factors have also led to the rise in the socially and politically destabilizing issue of social inequality. With these factors in mind, this essay will argue that the reason why the CCP’s ongoing efforts to address the rising levels of urban social inequality has remained largely ineffective is because it refuses to accept the inherent contradiction between market objectives (which prioritizes economic growth and profits) and social objectives (which prioritizes human welfare over profits). The CCP’s continued denial has therefore led to a situation where urban governments are not really coerced by the central government nor incentivized from producing and implementing social policy measures to address the rising levels of inequality since social welfare remains subordinate to China’s economic ambitions.

One could argue that these two factors are not necessarily exclusive, that the pursuit for a sustained economic growth is highly compatible with the socio-political issue of inequality. And, indeed, this has been witnessed in Japan, Taiwan, and, to some extent, South Korea (Copper 11; Jacobs 10–11). The difference with China, however, is that the combination of political decentralization and the hukuo system has created “invisible walls” within the country, essentially creating a form of a two-estate system (analogous to the French three-estate system) separating the population between those with urban hukuo and the migrant workers who predominantly have a rural hukuo (Chan). Under this system, “migrants are not guaranteed basic living protection; their children have difficulties in attending public schools in host cities; and a large number of migrants with illness or work-related injuries have to return to rural areas after they have dedicated their lives to working in urban factories for decades, due to the absence of labour protection” (Wu 35). Moreover, migrants who are interested in availing themselves some form of social welfare are then faced with the difficulty of transferring social insurance programs from one province/city to another (Xu et al 12; “Asia’s next Revolution”). Such unnecessary structural barriers, which are inherent in the current hukuo system, have led one scholar to suggest that it is now time for China to replace it with a unified hukuo (Zhang 8).

Introduced by the CCP in 1958, the present iteration of the old hukuo system has simply worsened the urban-rural distinction, particularly in the post-reform period. One of the reasons why the hukuo system is discriminatory is because, prior to the 1998 amendment allowing for hukuo to be inheritable from either the matriline or the patriline, one’s hukuo status was only inherited matrilineally. According to one scholar, the reason why the government decided to accord one’s hukuo status based on the mother’s hukuo is because women are supposedly less mobile than men which supposedly made them less likely to add more children to the urban population. What the scholar failed to mention, however, is this policy’s connection to China’s patriarchal culture and the expectation that women takes care of the children. Nevertheless, since one’s hukuo was inherited matrilineally (prior to the 1998 reform), people who were born in the cities but whose mothers have a rural hukuo were unjustly excluded as potential beneficiaries of social assistance, despite them living in the city all their life, since they inherited their mother’s rural hukuo status (Zhang 9).

Besides being inherently discriminatory to rural women, hukuo was intended primarily as a policy of control to limit the movement of people within China. But when China liberalized its economy in the 1980s, the restriction in the movement of people was also gradually eased. Still, apart from removing the matrilineal bias, the current hukuo system has largely remained unchanged. In fact, under China’s post-1980s capitalist economy, the hukuo system simply serves as an (unnecessary) barrier that severely limits the integration of migrant workers into their host cities, despite the fact that they have supplied the necessary manpower that has fueled China’s rapid economic growth for three decades. Indeed, it is quite ironic that despite their importance to the economy, it was only after 2003 that migrant workers were officially allowed to reside in cities. Prior to this, having no proper documents and employment certificates could mean detainment and repatriation to the countryside — almost like being domestically “deported” from a place of high social mobility to a place of severely limited social mobility (Xu et al. 10). Similar to a citizenship certificate, or a passport, hukuo allows for the distribution of limited public resources with the view of obtaining quality services for the local citizens; therefore, just like any temporary migrant workforce, migrant workers in China could not expect the same level of government service to someone who has an urban hukuo (Wu 39).

To further demonstrate the significance of the hukuo system as a major contributor to the social inequality in China, it is important to look at the ways one could avail an urban hukuo status. For the sake of brevity, however, this essay will simply outline the four options that the Guangzhou government requires. First, “the parents and spouses of local citizens can be entitled to equal citizenship, but are required to meet certain requirements of age, education level, and housing ownership.” Second, one must be paying income taxes in excess of RMB 100,000 three years in a row. Third, one must have “skills and knowledge that are in urgent demand by employers” (e.g., academics from a renowned institution; “doctorate degree holders from overseas, experts who own important patents,” etc.) Fourth, one must exchange his blue-stamped hukuo to a red-stamped one (Wu 36). Although this example is only partially representative of other urban hukuo jurisdictions in China, it nevertheless shows that one needs to be substantially wealthy, have a high level of (foreign) education, and the ownership of valuable patents, among other requirements, for one to be able to avail the privileges given to urban hukuo holders. In short, the hukuo system is highly discriminatory against outsiders, even to those who have benefited the local economy such as migrant workers.

Under Mao Zedong, China underwent a campaign of nationalizing privately owned enterprises. The resultant state-owned enterprises (SOEs) also functioned as welfare institutions since employment security, income, retirement protection, “housing, healthcare, foods, and education for their children” were all subsidized (Leung 189). This is often referred to as the “Iron Rice Bowl” welfare system (Zhang et al. 322). Aside from the employment-centred welfare system, the government was also involved in the care of “childless frail old persons, the disabled homeless and orphans.” The result is that in 1978 the level of urban China’s Gini coefficient was only 0.19 (Leung 189).

The subsequent economic reforms undertaken under Deng Xiaoping, however, led to the gradual dismantling of Mao’s egalitarian centrally-planned economy and welfare system in favour of the more entrepreneurial, private, and competitive capitalist free-market system (Zhang et al. 322). Deng Xiaoping believed that it is necessary to allow others to get rich first — a belief that is partly based on the neoliberal “trickle-down” economics that was gaining popularity during this same period across the world. Consequently, the structural changes in the economy caused the rise in cases of urban poverty and increased inequality.

China’s transition from a command economy obviously necessitated the dissolution and the downsizing of the bloated central government. The “decentralization in China is at one and the same time about dispersing power vertically within the state and dispersing power horizontally away from the state” (Mok and Wu 64). Evidently, economic decentralization has been a self-reinforcing process where local state actors benefited from the marketization process, therefore leading to greater push for more decentralization. On the one hand, decentralization has made China extremely economically competitive as city governments were able to attract foreign direct investments with the use of various incentives, such as low labour costs, lax environmental laws, tax breaks, etc. On the other hand, the focus on GDP growth has almost completely neglected other pertinent issues, such as the rising social inequality and the need for adequate social welfare for many, particularly migrant workers and their families. In fact, a national survey conducted in 2012 has revealed that income inequality is rated “the most severe, above corruption and unemployment” (Xie and Zhou 6928). This demonstrates the urgency of the problem of increasing income inequality in the post-reform era.

In 2006, the CCP leadership has officially recognized the problem of rising social inequality by announcing the need to transition from a GDP-centred growth to the creation of a “harmonious society,” or a less unequal society, in a bid to alleviate social tensions (Zhang et al. 319–20). In his speech on July 1, 2011, President Hu Jintao also expressed the need for a “people-centred approach to governance” (Shank and Wasserstrom 5; Mok and Wu 66). This sentiment was echoed at the Third Plenum of the Eighteenth Communist Party in 2013 with calls for a more inclusive economic growth (Lam and Wingender 3).

Within the context of competition under economic globalization, however, some Chinese cities are simply not keen on enrolling workers to a social insurance program in their bid to become more globally competitive (Mok and Wu 62; Xu et al. 12). Moreover, the combination of limited local funds, the discriminatory hukuo system, and the absence of any adverse political consequences for cities which refuse to provide social welfare to migrants, all translates to less incentives for local governments to do anything in terms of providing social assistance to “outsiders”. In addition, since the social insurance schemes are financed through local budgets, the general tendency is for urban governments to prioritize the needs of those with the urban hukuo and simply neglect the needs of migrant workers and their families (Mok and Wu 65). Most importantly, the fact that local CCP cadres are still being promoted based on their ability to deliver the economic targets at the expense of various social targets essentially undermines the requisite transition from a GDP growth-centric government policy to a social welfare-centric one.

Since the restructuring of SOEs in the 1990s, the CCP have obviously been very aware of the inherent dangers associated with the rise in social inequality in China. The restructuring of SOEs has resulted, not only in massive unemployment, but also in the loss of the social safety net known as the “Iron Rice Bowl.” To put this in perspective, SOEs employed 109.5 million at its apex in 1995, and this number declined rapidly to 69.2 million by the end of 2002 (Huang 74). What is troubling is that many of these newly unemployed were woefully unprepared to compete in the job market. Poorly educated, low skilled, and were already 40–50 years old, this group was expected to compete with around 10 million new entrants into the job market competing for an annual average of only 9 million new jobs being created (Leung 189). Coupled with the fact that China has a massive migrant population and is a rapidly aging society, employment-based social security system is clearly no longer an adequate option for many.

In analyzing China, it is necessary that one views the issue of social welfare through the context of the CCP’s legitimacy and survival. This means that one should be careful not to put too much confidence in the CCP’s resiliency, and one should also not overemphasize the CCP’s supposed susceptibility to following the experiences of the Soviet Union in the late 1980s. At the risk of portraying China as “exceptional”, one could definitely argue that China’s centuries old “imperial system” of governance means that the CCP’s success post-1949 is a reflection of its capacity to adapt to both the historical and contemporary realities of governing China. With these in mind, an article by Shank and Wasserstrom has expressed the interesting notion that “[u]ndemocratic and corrupt ruling groups can have surprising staying power, so long as they avoid internal fissures at the top and economic crises that undermine their ability to buy off members of other groups” (Shank and Wasserstrom 5). In the context of China’s current economic difficulties, it is certainly imperative that the central government does something to alleviate the hardships currently being experienced by many of its citizens. From the 1990s onwards, China has experienced increasing cases of street protests and riots related to “unpaid benefits, unfair remuneration in the distribution of severance pay from bankrupt firms, etc.” There were 8,700 in 1993, 11,000 in 1995, 15,000 in 1997, and doubling to 32,000 in 1999, reaching around 58,000 protests in 2003. Participants included farmers, workers, teachers, and students (Huang 74).

Arguably, the very uneven, volatile, and competitive nature of the global market ultimately means that not everyone would benefit from China’s economic development to the extent that migrant workers and their private-sector employers would be able to join the payroll-taxation-based and contributory insurance system since migrant workers often suffer from high insecurity of income and job and their private-sector employers often could not afford the level of mandatory contribution demanded by the government. Consequently, this means that migrant workers need a form of publicly-funded social safety net that provides “basic social welfare provisions such as a minimum living allowance and unemployment insurance benefits (including employment training) that can reduce their risks of falling into poverty in an economic downturn” (Huang 71).

It is important to recognize, however, that not all migrant workers share the same experiences. For example, migrants working in the manufacturing industry have a higher participation rate in social insurance programs compared to the service industry. This is because manufacturing is dominated by SOEs while the service industry is dominated by “private, individually held small businesses, such as restaurants and small stores” (Xu et al. 18). Generally, migrants working in SOEs in the late 1990s acquired employment-based social insurance programs which includes: (1) basic healthcare, (2) basic elderly pensions, (3) unemployment insurance, (4) occupational injury insurance, and (5) maternity benefits for working mothers. Except for maternity benefits, everything else require contributions from both employers and employees. These five basic social insurance programs have been made mandatory by the central government since 1999 for “state-owned and urban-collective enterprises, joint venture corporations (JVCs), and private companies that hire more than 50 workers” (Xu et al. 12).

What is shared by almost all migrant workers, however, is the high mandatory social security contributions demanded by the government for the employment-based social insurance system. Chinese workers are often required to contribute a minimum employee contribution based on the previous year’s average wage of the locality (Lam and Wingender 9). This means that the estimated 30 percent of the urban labour force who earns below the 60 percent threshold in several large cities are contributing more than they could afford. It is therefore not surprising that social security contributions are, by far, the largest burden for the low and middle-income urban households in 2012, constituting more than 90% of direct tax liabilities for most household (Lam and Wingender 10). Essentially, many Chinese citizens increasingly bear the financial burdens for purchasing housing, medical care and education services. Indeed, the government has been criticized for “denying its welfare and social protection responsibilities” (Mok and Wu 61). The government’s response was the 12th Five-Year Plan (2011–2015) with a view on expanding welfare services and “producing basic social security to the whole population beyond social equity” (Mok and Wu 62). Unfortunately, and expectedly, the plan has been hindered by a combination of the hukuo system, the decentralized welfare implementation, and the overarching pursuit for economic growth.

The variation in government enforcement of the social welfare requirements and, as already discussed above, the kind of industries that are located within a city are two major factors in the level of migrant workers’ participation in the urban welfare system. For instance, Kunshan City strictly abides by the legislated employer contribution of 20% for pension and 10% for healthcare. In contrast, Dongguan employers only contributes 10% and 2% for pension and healthcare respectively. For Wenzhuo, employers are essentially not obliged to contribute anything to healthcare. But Kunshan City is more selective of the kind of foreign investments that it allows, thereby offering less job opportunities for less-skilled migrant workers (Mok and Wu 70). In Kunshan, all workers are required to participate in the social insurance regardless of their hukuo. Thus Kunshan has more than 70% pension coverage. In terms of healthcare, each worker is required to pay 2% of the base wage, along with 8% from the employers. It also promises 90% compensation of the hospitalized expense. In brief, Kunshan is able to afford this level of social investment because it has been able to attract highly profitable high-tech industries and other capital-intensive industries. In addition, Kunshan maintains a strong oversight over big firms which allows for a more effective collection of social insurance premiums. This prevents “fee-evasion activities” from undermining the integrity of the whole social security system. The problem with Kunshan, however, is that it excludes migrant workers from the universal coverage. Kunshan manipulates the data by using “independent human resources companies, often run by powerful ex-officials” to essentially exclude some migrant workers from the universal coverage by using the loophole that exists for “outsourced labour” (Mok and Wu 69). Also, the example set by Kunshan is obviously not easy to replicate in all of China since the level of social welfare one receives is highly dependent on the financial capacity of the local government (Leung 191).

Perhaps, the largest obstacle to China’s efforts to successfully address its rising social inequality is its over-reliance on indirect taxes and non-progressive direct taxation, such as government funds, mandatory contributions, fines, and income from the SOEs, which often leads to middle- and low-income earners paying a much higher effective tax rate than high-income earners (Lam and Wingender 3). For example, China’s tax revenues accounted for about 22% of GDP in 2013 — somewhat lower than the average of 34% of GDP across the Organization for Economic Co-operation and Development (OECD) (Lam and Wingender 4). Moreover, China may appear to have a progressive individual income tax (IIT) system, with those in the highest income bracket (i.e., those earning 35 times the national average wage) taxed at 45 percent. But OECD countries often put their top marginal tax rates for personal income at around 4 times the national average. Obviously, there are huge disparities in terms of the per capita GDP between China and the OECD countries, but China’s taxation system is nevertheless not as “progressive” as it seems. In the end, IIT only accounts for about 5 percent of total tax revenue in China, thereby providing very little redistributive effects (Lam and Wingender 9). In 2011, only 9% of China’s GDP was spent on social expenditures, well below the OECD average of 20% (Kongshøj 580).

If analyzed through the lens of the central government’s decentralization of responsibilities to local governments, the decline in the share of local revenues in the national total has caused difficulties in some locales since the level of local government responsibilities has remained unchanged (Wu 37). Mok and Wu points out in their article that this financial shortfall is being filled by the local governments by using social security contributions which has filled the role of direct taxation (Mok and Wu 66). However, rather than boosting social expenditures, local governments are often more keen on investing on infrastructures believed to contribute to economic growth, thus reiterating the persistent problem associated with local CCP cadres still being promoted on the basis of their capacity to deliver the economic targets at the expense of various social targets (Mok and Wu 66).

The predictable outcome of all these is that China’s income inequality is worsening. Official data on income inequality for China is not available for the years between 2000 and 2013 since the government has stopped releasing data after the Gini coefficient reached 0.41 in 2000. When the government decided to release an update in 2013, the Gini coefficient was raised to almost 0.5, well below the 0.61 released by an independent study (Xie and Zhou 6928). Essentially, in the context of China’s rapid but unevenly distributed economic growth, the rich are getting richer much faster than the poor. Scholars indicate that in 2012 “the top quintile now captures 47 percent of the total income (up from 38 percent in 1980), while the lowest quintile accounts for only 4.7 percent (down from 8.7 percent)” (Cervic and Correa-Caro 3). As China’s underclass, migrant workers and their families are evidently at the forefront of the difficulties associated with the widening gap between the rich and poor.

In conclusion, this essay has shown that the rapid rise in China’s social inequality was brought on by the central government’s failure to reconcile the fundamentally incompatible relationship between the highly discriminatory hukuo system, the decentralization of social and economic responsibilities to local governments, and the overarching desire to sustain China’s economic growth. As demonstrated by a number of examples, such as the exclusionary requirements for acquiring an urban hukuo in Guangzhou, the discriminatory social policies that privileges people by virtue of their birth, the difficulties experienced by migrants in terms of transferring their social welfare plans from one province/city to another, etc., it is clear that the hukuo system in the post-reform period has now outlasted its purpose. Privilege breeds privilege, and the privileges that the two-estate system that the hukuo system represents has now become inconsistent in the face of rising inequality under China’s supposedly socialist government. For China’s millions of migrant workers, the persistence of the discriminatory hukuo system has left them in a limbo, unable to acquire a hukuo status in their host cities and unable to get the standard of living that they desire in their home provinces (Wu 40).

The CCP’s attempt to maintain the employment-based welfare system, a legacy of China’s pre-reform “Iron Rice Bowl” welfare system, has only worsened inequality as the lower- and middle-classes are often forced to contribute a significant share of their income to the system. Scholars have raised the issue of China’s gross underutilization of (progressive) direct taxation, which means that China has, for years, been “privatizing” the welfare of many migrants working outside of SOEs and highly profitable non-state sector companies.