This article investigates whether market competition enhances the incentives of Chinese industrial firms to avoid corporate income tax. We estimate the effects of competition on the relationship between firms' reported accounting profits and their imputed profits based on the national income account. To cope with measurement errors and potential endogeneity, we use instrumental variables, exogenous policy shocks and other robustness analysis. We find robust and consistent evidence that firms in more competitive environments engage in more tax avoidance activities. Moreover, all else equal, firms in relatively disadvantageous positions demonstrate stronger incentives to avoid corporate income tax. Copyright � The Author(s). Journal compilation � Royal Economic Society 2009.

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.We propose entertainment and travel costs (ETC) expenditures as a measure of corruption in Chinese firms. These expenses are publicly reported in firms' accounting books, and on average they amount to about 3 percent of a firm's total value added. We find that ETC is a mix that includes grease money to obtain better government services, protection money to lower tax rates, managerial excesses, and normal business expenditures to build relational capital with suppliers and clients. Entertainment and travel costs overall have a significantly negative effect on firm productivity, but we also find that some components of ETC have substantial positive returns to firms.

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Social learning has attracted increasing attention in the economics literature. The general concept of social learning encompasses many mechanisms through which individuals may learn from others. In particular, it includes the mechanism in which individuals learn from each other through direct (formal or informal) communications; it also includes the mechanism of observational learning where the behavior of individuals is influenced by their observation of other people's choices because of the information contained therein. 1Convincing empirical evidence about the importance of observational learning is not only relevant for the theoretical literature in economics; it also has policy implications. The key difference between direct communications and observational learning as channels of social learning lies in whether temporal, spatial, and social proximity among individuals is important for learning to occur. Observational learning can take place as long as the underlying decision problems faced by individuals are similar; in contrast, learning from others via direct communications requires individuals to be close in time, space, and social distance. As a result, if a policy maker wants to, say, expedite the adoption of an advantageous technology, an information campaign about the technology's popularity among other groups of agents will be effective if observational learning is important, but will not be effective if, instead, direct communication is the main channel of social learning.1 Albert Bandura (1977) wrote the pioneering book in psychology that started the research on social and observational learning. Abhijit Banerjee (1992) andIvo Welch (1992) Durham, NC 27708-0097, NBER, and SHUFE (e-mail: hanming.fang@duke.edu). The Institute for Social and Policy Studies (ISPS) at Yale University funded this project. We are most grateful to Donald Green, Director of ISPS, for his important suggestions regarding the experimental design and general guidance about field experiments. We would also like to thank Paul Dudenhefer, Dean Karlan, Enrico Moretti, Emmanuel Saez, Lan Shi, and especially three anonymous referees and the coeditor for helpful comments. Finally, we thank the managers in Mei Zhou Dong Po restaurant chain for their enthusiastic participation and cooperation in this field experiment. All remaining errors are ours.