Capital Mobility and Taxation: State–Business Collusion in China

Abstract

AbstractDo more mobile firms pay lower taxes? Conventional wisdom argues that capital mobility creates downward pressure on corporate taxes, as firms can threaten to exit. Nevertheless, empirical findings are highly mixed and hard to reconcile, partly due to a lack of data at the microlevel. 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 pay higher effective tax rates. We contend that this counterintuitive finding results from the strategic interaction between firms and governments. Knowing their vulnerability and sunk cost, firms with more fixed assets were more active in protecting themselves by bribing and colluding with local officials. Meanwhile, officials were more willing to seek bribes from these firms in exchange for tax cuts. In contrast, mobile firms were disadvantaged. Although capital mobility may provide additional bargaining power, firms with fixed assets can overcome this advantage through state–business collusion. Our quantitative and qualitative evidence show that fixed firms paid lower taxes in cities with cozy government–business relations. However, such advantages decreased after the launch of anti-corruption campaigns and in cities with higher fiscal transparency.