Capital Mobility & Taxation in Non-OECDCountries – Evidence from China

Abstract

Do more mobile firms pay lower taxes? Much research contends that capital mobility creates downward pressure on corporate taxes, as firms can threaten to exit. A substantial share of the existing work, however, is based on country average statutory tax rates in OECD countries. We instead explore this relationship at the firm level in China. Using two comprehensive panel data sets with more than 780,000 Chinese firms over two decades, we find that firms with higher shares of mobile capital, in fact, pay higher effective tax rates. We then explore potential explanations for this counter-intuitive finding using both quantitative and qualitative evidence. We argue that in an environment lacking fiscal transparency and rule of law, collusion between local governments and businesses can partially explain the positive relationship between capital mobility and tax rates. Firms with more fixed assets have stronger incentives to invest in connections with local officials in exchange for lower tax rates compared to their mobile counterparts. We provide evidence that the positive relationship between capital mobility and tax rates is more pronounced in contexts with cozier government-business relations and less transparency.