Abstract
This paper develops a theoretical model with a dual tax system that provides preferential treatments for foreign investment. The study suggests that in order to benefit from the preferential tax incentives and gain better property rights, high-productivity domestic firms intend to disguise as foreign firms via a practice of round-tripping. These preferential policies not only lead to government revenue losses; they also impose a higher tax rate on low-productivity and small firms. In addition, the study uses numerical simulation techniques to illustrate the impact of China’s corporate income tax reforms in 2008. We find that China’s domestic investment could decrease along with FDI under the unified system, though the tax rate on domestic firms falls.
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