Tax Collector or Tax Avoider? An Investigation of Intergovernmental Agency Conflicts

Abstract

Local governments play dual, but conflicting, roles in China's tax system. That is, they are both tax collectors and controlling shareholders of firms subject to tax payments. We investigate how local governments balance their tax collection and tax avoidance incentives. We find that the conflicts between central and local governments arising from the 2002 tax sharing reform have led to more tax avoidance by local government-controlled firms, particularly when the local government's ownership percentage of the firms is higher than the tax sharing ratio. We also find evidence that the overall level of tax avoidance by local government-controlled firms in a region is positively associated with local fiscal deficits. As a high level of government ownership of corporations and intergovernmental tax sharing are common phenomena in many transitional economies, this study offers valuable insights into how the dual roles played by local governments affect tax policy enforcement in these economies. JEL Classifications: H26; H71; M40; G38.

Regional favoritism and tax avoidance: evidence from China

“…The R 2 in these models ranges from 0.12 to 0.14, comparable to studies that use Chinese data (For example, Tang et al . () reported R 2 of 0.071 in a similar tax avoidance model).…”

“…Therefore, the provincial governor, being the leader in local economic matters, should have significant influence on how LTBs wield their authority. For example, several studies find that tax enforcements are associated with local governments’ policy preferences (Tang et al ., ). A governor's preferences are likely to be carried out by the LTBs.…”

“…The Chinese tax system is two tiered and administered by both the National Tax Bureau (NTB) and local tax bureaus (LTBs). This allows local government officials to have a great influence on corporate tax burdens (Li and Zhou, ; Tang et al ., ; Bradshaw et al ., ). Provincial governors can endow tax favors to affiliated regions through targeted tax policies, weakened enforcement, and special tax rebates.…”

Corporate Tax Avoidance: A Literature Review and Research Agenda

“…As tax collectors, they are interested in maximizing tax revenue; as shareholders, their interests are in reducing taxes. Tang et al (2017) examined these potentially conflicting roles surrounding a change in the taxation-sharing ratio between the central and local governments in China. Before the change, all tax revenue collected by the local government stayed with the local government.…”

Accounting research in China: commemorating the 40th anniversary of reform and opening up

“…Chan et al (2010) show that the adoption of IFRS encourages tax avoidance since a departure from a tax-based accounting system can decrease book-tax conformity which is informative of tax noncompliance. Further, Tang et al (2017) find that the conflicts between central and local governments arising from the tax sharing reform in 2002 has led to more tax avoidance of local government-controlled firms and tax avoidance of local government controlled firms is positively associated with local fiscal deficits.…”