Speculation is swirling that China will scrap tax on interest income to help cool the stock market, but the idea is drawing frowns in some parts of the government. Abolishing the 20% withholding tax would make returns on deposits now negative after inflation more attractive and so might staunch a record outflow of cash from banks and into the stock market, economists say.

But Liu Shangxi, a deputy director with the Research Institute of Fiscal Science under the ministry of finance, said tampering with the tax to tackle a passing problem would run counter to Beijings intention to build a predictable taxation system. Tax changes are very serious. Taxes should not be adjusted in response to market conditions, Liu said.

A tax researcher with the Chinese Academy of Social Sciences, who declined to be named, was also sceptical about the rumoured move. The issue has never been put on the table in the government discussions Ive attended, though the academic debate is always there, she said.

The tax came under fire in March when 27 delegates to the Chinese Peoples Political Consultative Conference, a largely symbolic advisory council, proposed scrapping the tax.

The delegates said the tax, which was introduced in 1999, should be abolished because it had failed in its purpose of boosting consumption; moreover, it adds to the pain for depositors, especially when inflation-adjusted rates are in negative territory.

But the CASS researcher said it would be premature to adjust any one tax without taking account of the overall personal I-T system.

The debate over the tax has become acute because deposit rates now badly lag inflation. Demand deposits pay just 0.72%, while one-year certificates of deposit return 3.06% or 2.45% after tax. With consumer inflation running at a 27-month high last month of 3.4%, households withdrew a record 278.4 billion yuan ($36.5 billion) from banks in May. Most of the money apparently went into the surging stock market, which hit a record high on May 29.

Alarmed by the speed of the rally, the government tripled stamp duty in the early hours of the following day. The market lost 20% but has since recovered to within 5% of its record, prompting feverish talk of what steps the government might take next.