China takes action to reform the profit distribution system of its state-owned enterprises
　　
　　According to the State-owned Assets Supervision and Administration Commission of the State Council (SASAC), a new state-owned capital operational budget system is to be established by the end of 2006 and put into practice in 2007.
　　The establishment of this system is intended to standardize and improve the remuneration and distribution system of central SOEs. The most noticeable facet of the new system is expected to be the requirement for central SOEs to turn in profits to the state, which will end their privilege of delivering no profits, only taxes.
　　“We have come to an agreement with the Ministry of Finance, under which it will take charge of the formulation of the operating and budget system for state-owned enterprises on the whole, while the SASAC will concentrate on work for the 169 central state-owned enterprises,” said Commission Minister Li Rongrong.
　　Under the old budget system in the early years of the PRC’s founding, China’s state-owned enterprises would turn all their profits over to the state and receive the capital they need to make investments and cover losses. Since the taxation reform in 1994, SOEs have been allowed to retain all their profits after paying taxes.
　　Currently, China has 169 central SOEs, whose revenues amounted to 6.73 trillion yuan in 2005, up 19.8 percent year on year, with a profit of 627.65 billion yuan, up 27.9 percent over the previous year.
　　The SASAC is now considering profit collection methods tailored for different sectors and enterprises of different scales. Central SOEs such as wholly state-owned energy and telecommunications companies, which perform well, reap large profits and have well-developed managerial structures, will be the first enterprises involved in this pilot project.
　　
　　Current situation
　　
　　Most of China’s listed companies choose to distribute profits during March and June, when shareholders will gather together to work out a proper annual profit distribution plan. The situation is similar among listed state-owned enterprises.
　　But after the distribution plan is determined, profits produced by state shares often fall into the pockets of enterprises rather than going to the Ministry of Finance or the SASAC, which makes investments on behalf of the state.
　　Neither state-owned enterprises nor those that haven’t gone public are required to turn over annual profits to the state.
　　“State-owned enterprises are nourished by state financing and credits provided by state-owned banks, but ever since the system of tax distribution was adopted in 1994 the state has never demanded profits from these enterprises,” said Xu Shanda, Vice Director General of the State Administration of Taxation, at a conference earlier this year.
　　Ever since the 1994 tax reform, state-owned enterprises have been allowed to keep all the after-tax profits to themselves.
　　According to Louis Kuijs, a senior economist at the World Bank office in Beijing, this policy was brought into being because of four factors.
　　First, the policy is consistent with the concept that guided China’s reform of state-owned enterprises in the 1980s, that is, underlining the independence of SOEs from the government.
　　Second, during 1992 and 1993, the key of SOE reform lay in the expansion of enterprise independence and the reduction of government interference. If the government asked enterprises for profits, it would seem to run counter to the guiding principle of reform.
　　Third, while the corporation system and corporate governance mechanism remained theories on paper at that time, it was not easy to determine a universally acceptable profit-sharing system.
　　Fourth, when most state-owned enterprises were operating in the early 1990s with difficulties, it seemed more urgent for the government to put more capital into the enterprises instead of asking for their profits.
　　After more than a decade’s worth of efforts, on the whole, China’s state-owned enterprises have recovered and begun to make profits. Central SOEs in particular have been greatly upgraded in terms of scale and technologies thanks to years of reform and reorganization. Currently almost 70 percent of the profits made by state-owned enterprises are attributed to this group.
　　In a word, central SOEs are not what they were 10 years ago, when they had neither profits to turn over to the state nor to share within themselves.
　　“At present, we still don’t know how to use and distribute after-tax profits,” said Xu Shanda, Vice Director General of the State Administration of Taxation.
　　
　　The coming years
　　
　　In some areas of China, state-owned enterprises have already begun to turn over their profits to local governments.
　　Beijing, Shanghai and Shenzhen began to see pilot projects of the state-owned capital operational budget in 2003, with Beijing achieving success in collecting profits from SOEs that have received state input.
　　Profits to local governments are composed of two parts: a certain proportion of after-tax profits, dividends and bonuses, and income from the transfer of state-owned property rights and liquidation of the enterprises. In these three cities, it is usually the local SASAC office that receives these profits.
　　“When the state-owned capital operating and budget system is there, it’s possible that profits will be turned over to the Ministry of Finance,” said an official from the ministry.
　　The SASAC was considering establishing a budget system as early as 2003, but a dispute about who should take over the profits led to a failure in working out the final details.
　　As an investor on behalf of the state, the SASAC argues that it should be in charge of receiving the profits.
　　The problem now is where the collected profits and bonuses should go. Should they be handed over to the Ministry of Finance, or to the SASAC, which is to bring them under control as part of the “state-owned capital operational budget?”
　　Most Chinese economists and government officials prefer the Ministry of Finance to be the recipient of the profits.
　　Dr. Luo Jiangang at the Research Institute of Fiscal Science of the Ministry of Finance said that, as an institution of the State Council, the Ministry of Finance has always been responsible for practicing macro-control over the economy. He added that the ministry is also an institution responsible for the state’s public budget.
　　While it is reasonable for the SASAC, as an investor of non-monetary capital in major SOEs, to ask for some of the profits, the final right to reap the benefits belongs to the Chinese people. This fact requires that the profits be put into state coffers, Luo said.
　　Financial resources required by the SASAC are provided by the Ministry of Finance, and may be obtained in the form of financial allocations. The point of doing this is that the right of the SASAC to profits as the investor of state-owned capital is achieved while a complete state budget system is maintained.
　　According to Hu Angang, Director of the Center for China Study, Tsinghua University, only the Ministry of Finance is capable of managing state public budgets and keeping the balance of payments on behalf of the state. The goal of the reform of profit distribution in state-owned enterprises is not to decentralize central finances, but to ensure their unity, authority and standardization. The SASAC, which acts as an investor of state capital on behalf of the state, performs duties assigned by the State Council, but it is not another Ministry of Finance.
　　Yang Ruilong, Dean of the School of Economics at Renmin University of China, agrees that SOEs should turn over their profits to the Ministry of Finance, which is the undoubted symbol of state financial power. In his opinion, after it has collected profits, the ministry may establish a public fund committee--for example the State Investment Fund--to stipulate that these profits can only be used in public areas such as social security. The SASAC, however, would not only make investments in the public domain, but also in other areas. Under this situation, if it is the SASAC that handles profits, the capital would flow into profit-oriented sectors and this would go against the original intention of using the profits as public funds.
　　Two years ago, it was the SASAC that took charge of the Regulations on State-owned Capital Operational Budget, assisted by the Ministry of Finance, while now it is the latter that plays the leading role. This subtle change implies the possibility of the Ministry of Finance taking over profits from SOEs.
　　
　　Impact of reform
　　
　　Owing to the lack of policies on the state’s right of profit sharing in state-owned enterprises, enterprises are able to use all the after-tax profits for their own reinvestment.
　　Again, in accordance with Louis Kuijs of the World Bank, although a stable financing source that provides large amounts of retained profits will help to promote industrial development, this source is not without shortcomings, and these drawbacks will become more and more serious in an increasingly developed and complicated economy.
　　“The key problem is that internal capital distribution in enterprises that enjoy this stable financing source will not be supervised as strictly as in those which get capital from financial institutions. This will undoubtedly affect the efficiency of investment. If it is in a well-performing and promising company, it is all right to distribute part of the profits in the company, but if the company is not doing well, it’s better to distribute the profits among the company’s shareholders,” Kuijs said.
　　China Aviation Oil (Singapore) Corp. Ltd. suffered from $550 million in losses just because of the CEO’s decision to invest in petroleum derivatives. This serves as the most persuasive negative example of disastrous consequences from allowing enterprises to keep all the after-tax profits.
　　Nowadays, quite a number of China’s big SOEs are dreaming of entering the international market through the merger with or purchase of foreign enterprises. To collect part of these enterprises’ profits will effectively curb their desire for such blind investments.
　　As for the fear that taking over their dividends will affect the development of SOEs, Wang Zhigang, head of a research department under the Research Center of the SASAC, argues that the Chinese Government will take different measures in different sectors.
　　China’s SOEs can be classified into two categories: one type is struggling in competition, while the other holds a monopoly. The latter, which enjoys stable revenues due to an uncompetitive environment, is obliged to turn over a certain amount of profits to the government. The former, however, will not be required to do so, as it will diminish their competitiveness to take away too much from them.
　　After the establishment of the state-owned capital operating and budget system, only those well-performing and profitable SOEs will be required to turn in profits after they have kept a certain amount for reinvestment.

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