Corporate tax avoidance and government corruption: Evidence from Chinese firms

Abstract

This paper investigates the impact of government corruption on corporate tax avoidance in China. A new method of weighted imputed profit is introduced to measure the firm's true profit to improve the measurement of tax avoidance. Employing a large sample of nearly 600,000 firms from 1998 to 2007, the empirical results illustrate that government corruption is positively related to tax avoidance. More specifically, I find that a one standard deviation increase in government corruption corresponds to a 6% increase in tax avoidance by firms. I find consistent evidence when using a natural experiment, Tax Sharing Act in 2002. In addition, I find that domestic private firms tend to avoid a larger portion of their tax liabilities than foreign or state-owned firms. Moreover, this paper confirms that tax avoidance increases with tax rates. Overall, this paper suggests that fighting corruption in local governments may lead to higher rates of tax collection.