Do Political Connections Weaken Tax Enforcement Effectiveness?

Posted: 26 Dec 2017

See all articles by Kenny Lin

Kenny Lin

Lingnan University

Lillian F. Mills

University of Texas at Austin - McCombs School of Business

Fang Zhang

Hong Kong Baptist University (HKBU) - Department of Accountancy & Law

Yongbo Li

Hong Kong University of Science & Technology (HKUST)

Date Written: December 19, 2017

Abstract

This paper examines whether ties to politicians by corporate boards of directors weaken the effectiveness of tax authorities in constraining tax avoidance in China. We use a unique dataset to measure geographic time-variant tax enforcement, including the probability of income tax audit, the expertise of tax officers, and the consequences of underreporting tax liabilities. Based on a sample of 11,121 firm-years from 2003 to 2013, we find that the deterrent effect of the probability that a firm’s taxable income understatement will be detected and lead to heavy penalties is significantly undermined if the board is politically connected. To enhance our analysis, we use opportunities for income shifting, the most likely mechanism through which Chinese firms avoid taxes on an ongoing basis, to illustrate how connected boards exert power to unwind the constraining effect of tax enforcement. Overall, our results suggest that a board’s ties to politicians can be a significant challenge to the effective enforcement of tax compliance in a politically controlled economy.

Keywords: effective tax rates, income shifting, political connections, tax avoidance, tax enforcement

JEL Classification: H25, H26, M40

Suggested Citation

Lin, Kenny and Mills, Lillian F. and Zhang, Fang and Li, Yongbo, Do Political Connections Weaken Tax Enforcement Effectiveness? (December 19, 2017). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3090778

Kenny Lin

Lingnan University ( email )

Hong Kong
China

Lillian F. Mills (Contact Author)

University of Texas at Austin - McCombs School of Business ( email )

Austin, TX 78712
United States

Fang Zhang

Hong Kong Baptist University (HKBU) - Department of Accountancy & Law ( email )

Kowloon Tong, Kowloon
Hong Kong

Yongbo Li

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

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