Government Extraction and Firm Size: Local Officials’ Responses to Fiscal Distress in China
52 Pages Posted: 10 Aug 2015 Last revised: 29 Apr 2020
Date Written: April 24, 2018
This paper studies how government extraction behaviors respond to local fiscal distress in China. We exploit the 2002 Chinese Income Tax Reform which exogenously cut local government revenues from income taxes by roughly half. We find that, when facing fiscal distress, local officials resort to informal taxes, such as fees and levies, to supplement revenue. In comparison, we do not find comparable increases in formal taxes. On average, the increase in informal taxes recovered 75 percent of the local government revenue loss due to the reform. The increases are more pronounced along the intensive margin and are primarily driven by more informal tax extractions from large firms. We also find that the reform led to reductions in investment and growth rates of small firms and consistently more small firms in the total size distribution.
Keywords: Government extraction, informal tax, firm size, 2002 Chinese Income Tax Reform
JEL Classification: H32, H71
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