Endogenous cyclical corporate tax burden in China: The role of tax quotas and growth targets

• Author: Jun Zhang,Dandan Dang,Hongsheng Fang,Minyuan He
• Date: 01 December 2020
• DOI: http://doi.org/10.1111/twec.12958
• Published date: 01 December 2020

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wileyonlinelibrary.com/journal/twec World Econ. 2020;43:3314–3339.

© 2020 John Wiley & Sons Ltd

DOI: 10.1111/twec.12958

ORIGINAL ARTICLE

Endogenous cyclical corporate tax burden in China:

The role of tax quotas and growth targets

HongshengFang1,2

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MinyuanHe1

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DandanDang1

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JunZhang3

1School of Economics, Zhejiang University, Hangzhou, China

2Institute for Fiscal Big-Data & Policy of Zhejiang University, Hangzhou, China

3Fudan University, Shanghai, China

KEYWORDS

cyclicality of corporate tax burden, government spending, growth targets, tax collection, tax quotas

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INTRODUCTION

In recent years, the global economy has been in the doldrums and the recession has led many countries to

reduce the corporate tax burden by reducing statutory tax rates. Specifically, there has been a global wave

of tax cuts after the implementation of the US Trump Tax Reform Plan (Hannon,2017; Yan & Yu,2018).

The United Kingdom, France, Italy, Australia, Japan, Hungary and other developed countries, and China,

India, Argentina, Mexico and other developing countries, have formulated plans to reduce statutory tax

rates. However, it is noteworthy that tax enforcement in developing countries is very flexible (Cai &

Liu,2009), which is one of the major reasons for the huge difference between the statutory tax rate and

the actual tax burden (Liu,2018). As the largest developing country in the world, China faces the dual

constraints of tax quotas (Chen,2002) and growth targets (Xu & Liu,2017). On the one hand, tax quota

is a planned growth rate of tax revenue for local governments. The completion of the tax quotas directly

determines the promotion and material rewards of tax officials (Chen, Tang, Wu, & Yang,2015). Zheng

(2005) and Ma (2009) believe that accessing the performance of taxation administrations by completing

tax quotas may exacerbate local governments' blind pursuit of tax revenues, which transforms tax quotas

from projected goals into mandatory planned political tasks. During recessions, taxation administrations

have to strengthen the intensity of tax collection. On the other hand, growth targets are often used as

incentives for local officials who play a key role in the economy (Li, Liu, Weng, & Zhou,2019). In

order to stimulate local economic growth, local governments need to guide or allocate funds for specific

industries or economic activities, and make direct investments or encourage investing, which requires the

support of fiscal revenue. Under the annual balanced budget constraint (Sun & Lou,2017), local govern-

ments must increase annual tax revenue to support their spending, which would increase the corporate

tax burden instead. In short, although the central government is implementing countercyclical tax cuts to

reduce the corporate tax burden during recessions, local governments will intervene in taxes, resulting in

endogenous procyclical corporate tax burden during recessions.

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FANG ᴇt ᴀʟ

Using data from China Annual Survey of Industrial Firms and changes in price of exports and shock

of financial crisis as two instrumental variables,this paper identifies that corporate tax burden in China

is countercyclical during booms and procyclical during recessions,1 and the cyclicality is stronger in

enterprises whose corporate income taxes are levied by the Local Tax Bureau (LTB).2 How to explain

the cyclicality of corporate tax burden in China? Whether the goals of local governments (tax quotas and

growth targets) contribute or not? What is the channel through which tax quotas and growth targets af-

fect the cyclicality of corporate tax burden, respectively? Those are the questions that we will discuss in

depth.

Our study is related to the following literatures. The fiscal policy, working as a stabiliser in mac-

ro-control, has been the focus of concern in global academic circles. The extant studies point out that

fiscal policies are countercyclical or acyclical in developed countries, but are often procyclical in

developing countries (Alesina, Campante, & Tabellini,2008; Gavin & Perotti, 1997; Ilzetzki &

Vegh,2008; Talvi & Vegh,2005; Thornton,2009; Woo,2005). While most countries tend to “grad-

uate from fiscal procyclicality” and implement countercyclical fiscal policy, some developing coun-

tries are haunted by procyclicality (Frankel, Vegh Carlos, & Guillermo,2013). It is noteworthy that

most studies focus on the cyclicality of spending policy rather than the cyclicality of tax policy.

However, in extant literatures on the cyclicality of tax policy (Furceri & Karras,2011; Kaminsky,

Reinhart, & Vegh,2005; Sorensen, Lisa, & Yosha,2001; Sturzenegger & Werneck,2006), Vegh and

Vuletin (2015) point out that indicators of tax policy (inflation tax, tax revenues and average tax rate)

cannot reflect policy behaviours, and only statutory tax rate is a good substitute.3 They conclude that

tax policies are acyclical in developed countries and procyclical in developing countries4. As the

enforcement of tax law in developed countries mostly follows the principle of “collecting all receiv-

able taxes”, the cyclicality of tax policy measured by statutory tax rates can well reflect the cyclical-

ity of corporate tax burden, but this is not the case in China.

There are also some related extant literatures about China. Shi, Yin & Tang, (2019) conducts an em-

pirical analysis on the data of provinces in China and finds that the provincial average tax burden of the

National Tax Bureau (NTB) system is countercyclical, while the Local Tax Bureau (LTB) system has

procyclical average tax burden.5 Chen, Kong, and Wang (2016) study the cyclicality of tax avoidance in

listed SOEs and find that the degree of tax avoidance is lower in the economic downturn, which means

1This means enterprises in China face increasing corporate tax burden during both booms and recessions.

2Since tax sharing reform in 1994, the National Tax Bureau (NTB) system is under vertical management of the central

government, while the Local Tax Bureau (LTB) system is under management of local governments. In this paper, we divide

enterprises into two samples whose corporate income taxes are levied by the National Tax Bureau (NTB) and by the Local

Tax Bureau (LTB).

3Strawczynski (2014) studies the cyclicality of statutory tax rates in Israel and finds that while direct taxes are acyclical,

indirect taxes change procyclically. Srebrnik and Strawczynski (2016) find that countries with a high external debt may be

forced to be more procyclical, while Abdellatif and Tran-Nam (2016) argue that Egypt adopts procyclical tax policy in an era

of political transition.

4The result is based on the classification analysis on 20 developed countries and 42 developing countries for the period

1960-2013.

5Shi et al. (2019) argue that the cyclicality of national debt issuance affects the average tax burden of the NTB system, which

leads to countercyclicality of the NTB system, while shared taxes levied by the NTB system lead to procyclicality of the LTB

system.