Abstract
Since 1991, China has implemented two significant tax reforms. The first reform, in 1994, was a large-scale adjustment of the tax distribution system between the central and local governments, and the second reform, in 2012, replaced business tax with value-added tax. Also, the size of China’s underground economy decreased from 13.55% in 1995 to 12.30% in 2016. The paper presents an evaluation of the effect of the two tax reforms and the existing underground economy on GDP growth in China. GDP is defined as explained variable, the explanatory variables include: the ratio of declared income to actual income, the change of concealed income, and the influence of tax rate change on declared income and concealed income. According to the tax reform in 1994 and 2012, two dummy variables are set respectively. In methodology, this paper uses Simultaneous equations model, SUR-OLSs and Slutsky identity. Our estimation is based on the official statistics of China National Bureau of Statistics in the period from 1991 to 2019. In empirical analysis, we decomposed tax changes into tax rate effect (change of budget constraint slope) and income effect (change of tax liability), then analyzed the impact of tax elasticity on GDP growth. The empirical results demonstrate that both the 1994 tax reform and 2012 tax reform have had a positive impact on GDP, with high statistical significance respectively. The results also confirm that the increase of tax rate leads to the increase of hidden income, which eventually leads to the decrease of GDP. The offered methodology can also be applied to most countries for time series analyses.
Highlights
Arecent headline in the Globe and Mail read, “US Tax Cheating Worth $150 Billion”; a regional newspaper featured the “Under-the-Table Economy” over a full two pages, and the Ontario Legislature’s Standing Committee on Finance and Economic Affairs devoted more than a day to hearing expert evidence on tax evasion practices
While the range of estimates xi of the underground economy was large, a more precise understanding of the definitional differences used to calculate the different estimates revealed that the range was much narrower than had first appeared
Does the unemployment rate really mean what we think it means? In the Atlantic provinces, for example, where there has been evidence of considerably more underground economic activity than in the rest of the country, how do we account for the employment in the underground economy (UGE)? When we have a black economy, should we use the unemployment rate as an indication of economic cyclicality at all?
Summary
Arecent headline in the Globe and Mail read, “US Tax Cheating Worth $150 Billion”; a regional newspaper featured the “Under-the-Table Economy” over a full two pages, and the Ontario Legislature’s Standing Committee on Finance and Economic Affairs devoted more than a day to hearing expert evidence on tax evasion practices. These and other signs of heightened interest in the underground economic phenomenon raise some important questions. Our aim here is to define what constitutes the underground economy, discuss some issues related to measuring its size and growth, and explore its causes and the implications for business and policy decision makers.
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