Income Taxation of State-Owned Enterprises: Theory and Chinese Evidence

Abstract:     
This paper develops a theoretical framework for analyzing the corporate income taxation of state-owner enterprises (SOEs). SOEs are subject to income taxation in many countries, presenting a puzzle as to why a government would tax its SOEs in lieu of simply requiring distributions. I suggest that for SOEs and private firms alike, divergent interests between managers and shareholders imply that ensuring optimal payout policy is not costless. To the extent that the solutions for mitigating this agency problem in the private firm context cannot be adequately implemented for SOEs, taxing SOEs constitutes a mechanism for forcing distributions. This explanation of SOE taxation implies that SOEs may be sensitive to the income tax, contrary to the supposition of some economists and legal scholars. Although SOEs may be less tax-sensitive than private firms in certain circumstances, and although they can be made less tax-sensitive if the government shareholder gives SOE managers “credit” for tax paid, these depend on contingent factors. I discuss these factors by borrowing elements of the framework developed by Chetty and Saez (2007) for analyzing the incentives of managers with respect to dividend payout. Moreover, I present non-quantitative empirical evidence from China suggests that SOEs may be rather tax-sensitive, which means that forcing distributions from them through the income tax may inflict tax distortions on the public sector.

Working Paper Series