Asymmetric Corporate Tax Compliance: Evidence from a Tax Reform in China

Abstract

Using the 2008 corporate tax reform in China as a quasi-natural experiment, we find that compared to unaffected firms, firms facing tax increases report significantly lower profit margins to avoid paying more taxes, while there is no significant difference for firms facing a tax cut. Our results remain valid after we control for firm fixed effects or instrument firms’ pre-reform tax rates by the plausibly exogenous historical variations in Qing China. We further find that tax increase firms only start to under-report their profits after 2008 when the tax reform became effective, no actions are undertaken in 2007 when the reform was announced. In contrast, tax cut firms under-report their profits in 2007 once they realized the tax decrease in the following years. Lastly, we find that the asymmetric reactions are only valid for private firms, but not for state-owned firms.