Top

International Tax and Public Finance

Published in:

22-05-2019

Intergovernmental revenue relations, tax enforcement and tax shifting: evidence from China

Author: Chengrui Xiao

Published in: International Tax and Public Finance | Issue 1/2020

Activate our intelligent search to find suitable subject content or patents.

search-config

AI-assisted search

Off

Abstract

This paper provides empirical evidence on how intergovernmental revenue relations would affect governments’ incentives on tax enforcement in a developing country. By taking advantage of the exogenous shock induced by China’s corporate tax income revenue sharing reform in 2002, I find that the local governments would increase tax enforcement on local business tax and surcharges (BTS) to offset the adverse fiscal shock. In addition, such tougher tax enforcement was heterogeneous across firms. The increased effective BTS was mostly driven by non-state-owned enterprises and domestic firms. This paper further shows that the incidence of corporate tax could be passed onto workers through lower wages and benefits. On average, the share of corporate tax burden borne by workers in China is approximately 62%, which is higher than the estimate in Germany (Fuest et al. in Am Econ Rev 108(2):393–418, 2018).

previous article Marijuana tax incidence, stockpiling, and cross-border substitution

next article Which households matter most? Capturing equity considerations in tax reform via generalised social marginal welfare weights

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

In this paper, the term ‘local governments’ refers to all subnational governments, including provincial, prefectural and county governments.

The FIEs refer to firms with investors from foreign countries and also from Hong Kong, Macau and Taiwan.

Chen (2017) also shows that the VAT enforcement could be reduced when the county obtains a smaller share of VAT revenue after sharing with the provincial and prefectural governments. This finding also confirms that the intergovernmental revenue sharing could shape the lower layers of governments’ incentives on tax enforcement.

The personnel appointment and the funding for the SAT are all determined by the upper layers of SAT, although the party leader of a local SAT is supervised by the party secretary in the same jurisdiction. See Chen (2017) for more detailed discussion.

In 2003, the LBT of Beijing municipality announced to rectify the problems regarding various unauthorized charges imposed on firms. The document issued by the LBT of Beijing municipality gives detailed examples about how the LBT might charge firms with arbitrary fees and fines. (Available on line: http://zfxxgk.beijing.gov.cn/110026/qtwj22/2008-04/21/content_48078.shtml)

The local governments could use various methods to lower effective tax rates, including the illegal extension of the tax exemption period, granting the unqualified firms with the tax preferences for high-technology and eco-friendly enterprises, unauthorized extension of tax payment, negotiating the ‘revenue loss’ contracts to help enterprises to hide true profit from the central government, turning a blind eye to the tax evasion activities, etc.

The Great Western Development program is intended to narrow social and economic gaps between inland and coastal China. The program targets six provinces, five autonomous regions, and one municipality in underdeveloped western China.

In fact, the effective CIT revenue share retained by local governments varied across provinces. From 2002 to 2007, the average CIT revenue retain share of Beijing was only 17.33%, while this number in Sichuan province was 73.67%. (Data source: China Taxation Yearbook, 2002–2007).

In 2000, the proportion of the CIT revenue in total local tax revenue was around 10%.

To alleviate the negative revenue shock on local governments, the center designed the CIT revenue benchmark for each provincial government. If the CIT revenue share retained by provincial governments fell below the benchmark, the center would refund the provincial governments to ensure that the CIT revenue retained by provincial governments would reach the benchmark. See Lei (2016) for more detailed discussion regarding the CIT benchmark.

Theoretically, after 2002, 40% of the SDEs’ CIT revenue belonged to local governments. However, in practice, since the CIT settlement and payment of SDEs are conducted in their headquarters, which are located in Beijing, the central government still secured most CIT revenue of SDEs after the 2002 CIT revenue sharing reform.

Most of the SDEs in the control group are state-owned absolute holding firms, which would remit partial profit to the central government. As a result, the average tax compliance of SDEs may be higher than the rest of firms since they cannot obtain all benefits from tax avoidance. To control for the potential tax compliance difference between SDEs and the rest of the firms, the variable SOE_share, defined as the share of state-owned capital to the total capital, is included into regressions.

According to the National Bureau of Statistics of China, the above designated size enterprises are defined as those firm with annual sales above 5 million RMB (around US$750,000).

First, the observations with invalid or duplicate identification numbers are excluded. Second, I drop observations with missing values of annual sales, total assets, net fixed assets, employment, and gross industrial output. Third, I restricted the sample to firms with more than 10 employees. Fourth, all observations violating following generally accepted accounting principles (GAAP) are excluded. (1) Net fixed assets must be smaller than total assets. (2) Liquid assets must be smaller than total assets. (3) Paid-in capital, interest payment, and exports must be non-negative. (4) A firm’s profit ratio must stay between 0.1% and 99%. (5) The year when a firm was established should not exceed the year when it was surveyed.

For example, the urban maintenance and construction tax and the surcharge for local education account for a large portion of the total surcharges and for roughly 10% of total business tax and VAT payment. The land increment value duty is charged only if a property transaction occurs. The resource tax is generally paid by firms in petroleum and natural gas industry, mineral industry and coal industry.

The same robustness checks on firms’ effective VAT are also conducted. The parallel trend assumption and the validation of the control group are all satisfied. The coefficients of the interaction terms remain statistically insignificant in both dynamic effects and subsample analyses. To save space, the results of robustness checks regarding effective VAT are not reported in the paper, but these results are available upon request.

For example, to ensure the financial stability of the prefectural governments, Hubei province specifically pointed out that the increased revenue obtained by provincial government would be reimbursed as the transfer payment to prefectural governments. Shanghai also mentioned that the province-level municipality government would offer assistance to counties that had financial difficulties due to the 2002 CIT revenue sharing reform.

In general, the firms qualified for the 3-year CIT exemption are the FIEs, the high-technology firms, the eco-friendly corporations and those investing into public infrastructures and public services.

In this paper, SOEs are defined as those enterprises with more than 50% of the state-owned capital in their corporate ownership.

The formula used to calculate the share of corporate tax incidence borne by workers is $ I^{w} = \frac{{wL\widehat{\delta }(1 - t)}}{{(1 - \tau )T - wL\widehat{\delta }(t - \tau )}} $, where w is workers’ total wage bill, L is the quantity of labor, T is the tax base, t is the personal income tax rate, τ is the BTS rate, and $ \widehat{\delta } $ is the estimated elasticity of the wage bill with respect to effective BTS. Except for $ \widehat{\delta } $, the variables in the formula are plugged in by using the numbers of the sample average. Specifically, w = 14,968, L = 250, T = 4,148,000, t = 0.1 and τ = 0.0706.

The first-stage results and the estimated coefficients of the other control variables in the second-stage are available upon request.

Almunia, M., & Lopez-Rodriguez, D. (2018). Under the radar: The effects of monitoring firms on tax compliance. American Economic Journal: Economic Policy,10(1), 1–38.

Arulampalam, W., Devereux, M. P., & Maffini, G. (2012). The direct incidence of corporate income tax on wages. European Economic Review,56(6), 1038–1054.CrossRef

Auerbach, A. J. (2006). Who bears the corporate tax? A review of what we know. Tax Policy and the Economy,20, 1–40.CrossRef

Bai, C. E., Lu, J., & Tao, Z. (2006). Property rights protection and access to bank loans. Economics of Transition,14(4), 611–628.CrossRef

Bauer, T. K., Kasten, T., & Siemers, L. H. (2012). Business taxation and wages: Evidence from individual panel data (p. 6717). No: IZA Discussion Paper.

Bertrand, M., Duflo, E., & Mullainathan, S. (2004). How much should we trust differences-in-differences estimates? The Quarterly Journal of Economics,119(1), 249–275.CrossRef

Besley, T., & McLaren, J. (1993). Taxes and bribery: The role of wage incentives. The Economic Journal,103(416), 119–141.CrossRef

Besley, T., & Persson, T. (2009). The origins of state capacity: Property rights, taxation, and politics. American Economic Review,99(4), 1218–1244.CrossRef

Besley, T., & Persson, T. (2014). Why do developing countries tax so little? Journal of Economic Perspectives,28(4), 99–120.CrossRef

Brandt, L., & Li, H. (2003). Bank discrimination in transition economies: Ideology, information, or incentives? Journal of Comparative Economics,31(3), 387–413.CrossRef

Cai, H., & Liu, Q. (2009). Competition and corporate tax avoidance: Evidence from Chinese industrial firms. The Economic Journal,119(537), 764–795.CrossRef

Che, J. (2002). Rent seeking and government ownership of firms: An application to China’s township–village enterprises. Journal of Comparative Economics,30(4), 787–811.CrossRef

Chen, S. X. (2017). The effect of a fiscal squeeze on tax enforcement: Evidence from a natural experiment in China. Journal of Public Economics,147, 62–76.CrossRef

Chen, Y., Li, H., & Zhou, L. A. (2005). Relative performance evaluation and the turnover of provincial leaders in China. Economics Letters,88(3), 421–425.CrossRef

Cragg, J. G., Harberger, A. C., & Mieszkowski, P. (1967). Empirical evidence on the incidence of the corporation income tax. Journal of Political Economy,75(6), 811–821.CrossRef

Dwenger, N., Rattenhuber, P., & Steiner, V. (2017). Sharing the burden? Empirical evidence on corporate tax incidence. German Economic Review. https://doi.org/10.1111/geer.12157.

Feenstra, R. C., Li, Z., & Yu, M. (2014). Exports and credit constraints under incomplete information: Theory and evidence from China. Review of Economics and Statistics,96(4), 729–744.CrossRef

Felix, R. A., & Hines Jr, J. R. (2009). Corporate taxes and union wages in the United States. NBER working paper, no. w15263.

Fuest, C., Peichl, A., & Siegloch, S. (2018). Do higher corporate taxes reduce wages? Micro evidence from Germany. American Economic Review,108(2), 393–418.CrossRef

Gordon, R., & Li, W. (2009). Tax structures in developing countries: Many puzzles and a possible explanation. Journal of Public Economics,93(7–8), 855–866.CrossRef

Gordon, R. H., & Li, W. (2012). Provincial and local governments in China: Fiscal institutions and government behavior. In J. Fan & R. Morck (Eds.), Capitalizing China (pp. 337–369). University of Chicago Press.

Gravelle, J. G., & Smetters, K. A. (2006). Does the open economy assumption really mean that labor bears the burden of a capital income tax? The B.E. Journal of Economic Analysis & Policy, 6(1), 1–42.

Harberger, A. C. (1962). The incidence of the corporation income tax. Journal of Political Economy,70(3), 215–240.CrossRef

Khan, A. Q., Khwaja, A. I., & Olken, B. A. (2015). Tax farming redux: Experimental evidence on performance pay for tax collectors. The Quarterly Journal of Economics,131(1), 219–271.CrossRef

Kleven, H. J. (2014). How can Scandinavians tax so much? Journal of Economic Perspectives,28(4), 77–98.CrossRef

Kleven, H. J., Knudsen, M. B., Kreiner, C. T., Pedersen, S., & Saez, E. (2011). Unwilling or unable to cheat? Evidence from a tax audit experiment in Denmark. Econometrica,79(3), 651–692.CrossRef

Kleven, H. J., Kreiner, C. T., & Saez, E. (2016). Why can modern governments tax so much? An agency model of firms as fiscal intermediaries. Economica,83(330), 219–246.CrossRef

Kopczuk, W., Marion, J., Muehlegger, E., & Slemrod, J. (2016). Does tax-collection invariance hold? Evasion and the pass-through of state diesel taxes. American Economic Journal: Economic Policy,8(2), 251–286.

Kumler, T., Verhoogen, E., & Frıas, J. (2013). Enlisting workers in monitoring firms: Payroll tax compliance in Mexico. NBER working paper, no. 19385.

Kung, J. K. S., & Ma, C. (2018). Friends with benefits: How political connections help to sustain private enterprise growth in China. Economica,85(337), 41–74.CrossRef

Lei, Y. H. (2016). Can governments harvest connections with firms? Evidence from China. Yale-NUS College working paper.

Li, H., Meng, L., & Zhang, J. (2006). Why do entrepreneurs enter politics? Evidence from China. Economic Inquiry,44(3), 559–578.CrossRef

Li, H., & Zhou, L. A. (2005). Political turnover and economic performance: The incentive role of personnel control in China. Journal of Public Economics,89(9–10), 1743–1762.CrossRef

Liu, L., & Altshuler, R. (2013). Measuring the burden of the corporate income tax under imperfect competition. National Tax Journal,66(1), 215–238.CrossRef

Liu, Q., & Lu, Y. (2015). Firm investment and exporting: Evidence from China’s value-added tax reform. Journal of International Economics,97(2), 392–403.CrossRef

Liu, Y., & Martinez-Vazquez, J. (2014). Interjurisdictional tax competition in China. Journal of Regional Science,54(4), 606–628.CrossRef

McMillan, J., & Woodruff, C. (2002). The central role of entrepreneurs in transition economies. Journal of Economic Perspectives,16(3), 153–170.CrossRef

Naritomi, J. (2015). Consumers as tax auditors. Working paper. London School of Economics.

Pomeranz, D. (2015). No taxation without information: Deterrence and self-enforcement in the value added tax. American Economic Review,105(8), 2539–2569.CrossRef

Shleifer, A., & Vishny, R. W. (1994). Politicians and firms. The Quarterly Journal of Economics,109(4), 995–1025.CrossRef

Slemrod, J., Blumenthal, M., & Christian, C. (2001). Taxpayer response to an increased probability of audit: Evidence from a controlled experiment in Minnesota. Journal of Public Economics,79(3), 455–483.CrossRef

Xu, C. (2011). The fundamental institutions of China’s reforms and development. Journal of Economic Literature,49(4), 1076–1151.CrossRef

Zhang, J. (2011). Interjurisdictional competition for FDI: The case of China’s “development zone fever”. Regional Science and Urban Economics,41(2), 145–159.CrossRef

Zheng, Y. (2006). Fiscal federalism and provincial foreign tax policies in China. Journal of Contemporary China,15(48), 479–502.CrossRef

Title: Intergovernmental revenue relations, tax enforcement and tax shifting: evidence from China
Author: Chengrui Xiao
Publication date: 22-05-2019
Publisher: Springer US
Published in: International Tax and Public Finance / Issue 1/2020
Print ISSN: 0927-5940
Electronic ISSN: 1573-6970
DOI: https://doi.org/10.1007/s10797-019-09546-9

Springer Professional

Abstract

Please log in to get access to your license.

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Springer Professional "Wirtschaft"

Other articles of this Issue 1/2020

Modeling fiscal sustainability in dynamic macro-panels with heterogeneous effects: evidence from German federal states

Why the Norwegian shareholder income tax is neutral

Taxing aid: the end of a paradox?

Do the rich pay their taxes early?

Long-term care and myopic couples

Which households matter most? Capturing equity considerations in tax reform via generalised social marginal welfare weights