Tax Enforcement and Corporate Labor Income Share: Evidence From a Quasi-Natural Experiment in China

Abstract

This study examines the effects of stricter tax enforcement on the labor income share of firms in China, using the merger of the State Tax Bureau (STB) and Local Tax Bureau (LTB) as a quasi-natural experiment. We employ a difference-in-differences (DID) approach and find that after the merger, tougher tax enforcement leads to a decrease in the labor income share of firms. This effect is particularly pronounced in firms that are highly reliant on labor or have lower tax transfer abilities. The mechanism tests indicate that stricter tax enforcement increases tax burdens, financing costs, and financing constraints, and decreases tax avoidance, leading to higher fixed assets investment and reduced human capital investment. These results are in line with the financing constraint channel. The findings remain robust when subjected to parallel trend testing, alternative variable measurements, and sample selection, excluding the impact of other policies and anticipation effect. Our findings can inform policymakers in their efforts to modernize and transform the tax governance system, reduce the income gap, and promote common prosperity.