The Political Dynamics of Corporate Tax Avoidance: The Chinese Experience

Abstract

In China's political selection system, officials capable of growing local economies are reward-ed with promotions. Eager to demonstrate economic achievements, newly appointed local lead-ers may raise tax revenues to expand fiscal expenditures on infrastructure projects. Against this backdrop, we study how political appointments influence local firms' tax planning. Based on a sample of locally administered state-owned enterprises (SOEs), we find firms decrease their tax avoidance after new leaders take office. The political-turnover effect on these firms' tax positions is more evident when the incoming leaders have more political clout over SOE managers, the incentives to divert resources are stronger, or politician-manager networks are present, and subsides following the launch of the anticorruption campaign. Furthermore, firms with higher post-turnover tax payments subsequently receive more government contracts or subsidies. Overall, our findings suggest political incentives shape the tax-planning activities of SOE managers in a "two-way favor exchange" manner.