Missing social security contributions: the role of contribution rate and corporate income tax rate

Abstract

Social security compliance by firms is critical to the welfare of workers and the sustainability of the program. Partly because of weak law enforcement, social security evasion—failure to participate or only partially pay the contributions—is severe in developing countries. In this study, we examine how social security evasion by firms is determined by two policy parameters: social security contribution rate and corporate income tax rate. Using a novel longitudinal dataset of firms in China, we exploit city-by-year variations in social security contribution rate and variations in corporate income tax rate generated by a 2008 corporate tax reform. Findings suggest that the two policy parameters have opposite effects on social security evasion, namely social security contribution rate has a positive effect on evasion, and corporate income tax rate has a negative effect. The negative effect of corporate income tax is as expected because a high corporate tax rate reduces the effective costs of social security contributions, which are deductible. The estimated effects of the policy parameters are pronounced among private-owned domestic firms and firms in cities where a formal labor contract is less common. Findings suggest that corporate tax rate can be used as a companion policy instrument with social security contribution rate to combat social security evasion in developing countries.