Abstract
In this Policy Watch study, we explore the different approaches to corporate income tax (CIT) setting in three economically significant regions: USA, EU, and People’s Republic of China (PRC). We characterize tax-setting in the three regions as occurring at three hierarchical levels and examine the impact of this on tax competition. We find that there is considerable heterogeneity across the regions. The approach in the PRC is particularly notable. While the PRC has established centralized rate of CIT at the highest level, it is unique in having a tax-sharing system with its lower tiers of government. This connection between the different levels of government within the PRC plays a crucial role in China’s unique CIT rate-setting agenda that results in intense and tacit inter-jurisdictional tax competition.
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Notes
USA excludes Puerto Rico and District of Columbia; EU membership as of 01 February 2020; PRC refers to mainland China.
Effectively we are focusing on FDI decisions where the firms have a geographical preference, perhaps to access consumers, but have yet to decide upon a specific location within the region. Their choices will be influenced by, inter alia, differences in the CIT rates among the potential investment locations.
An FIE is a legal form allowing the company to operate in the PRC. It can take a wide range of forms, including equity joint ventures, cooperative joint ventures, wholly-owned foreign enterprises, and foreign-invested companies limited by shares.
The policy speculates that: (i) if the R&D expenses are recorded into the profits or losses of the current period but have not resulted in intangible assets, then the firms can enjoy an extra 50% deduction of the actual expenses from calculating their tax liability. This equates to a net saving of 12.5% for eligible expenses, compared with the standard 25% CIT rate; (ii) if the R&D expenses have resulted in intangible assets, 150% of which can be amortized over at least 10 years (Jia and Ma, 2017).
To qualify for HTE status, the enterprises must meet several criteria, such as conducting business in a designated high- and new-technology sector, earning at least 60% of total sales from high- and new-technology products and services, engaging at least 10% of total workforce in R&D related work, and investing 3% to 6% of total revenue in R&D (Jia and Ma, 2017).
Li and Zhou (2005) provide empirical evidence that the central government indeed employs personnel control over promotion and termination of provincial governors to induce provincial economic growth. As those authors show, a better economic performance increases a provincial governor’s probability of being promoted and it decreases the probability of termination of their careers.
In 2018, a tax administration reform was implemented in China. The state and local tax bureaus merged into a consolidated tax authority. This new tax authority is responsible for all functions formerly performed by the corresponding state and local tax bureaus.
See Liu et al. (2015) for a detailed discussion of the expenditure assignment in China.
While local tax bureaus are essentially operational departments within local governments, the state tax bureaus are under the supervision of central authority. However, in practice, the taxing behaviors of state tax bureaus are also subject to the influence of local governments, as they physically locate in the domains controlled by local officers (Liu and Martinez-Vazquez, 2014). Nevertheless, the recent merger of state and local tax bureaus into a consolidated tax authority in 2018 is expected to further centralize tax administration and enable tax information to be monitored more comprehensively by the central authority, thereby reducing local discretion in setting effective tax rates. A full investigation of this point is outside the scope of the current paper and the extent of this change will be watched and analyzed when more recent data become available.
Figure 6 in the Online Appendix lists the corresponding names of the Chinese provinces in the maps.
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Acknowledgements
We are grateful to the editor (Ron Davies) and anonymous referees for their helpful comments and suggestions. Yongzheng Liu acknowledges research funds from the National Natural Science Foundation of China (No. 72173123, No. 71773128, and No. 71533006) and the Beijing Municipal Social Science Foundation for Young Academic Leaders (No. 21DTR009). Jie Ma’s research is supported by a grant from the National Natural Science Foundation of China (No. 71773015). The usual disclaimer applies.
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Hynes, K., Liu, Y., Ma, J. et al. Tax competition for FDI: China’s exceptional approach. Int Tax Public Finance 29, 788–809 (2022). https://doi.org/10.1007/s10797-021-09709-7
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DOI: https://doi.org/10.1007/s10797-021-09709-7