Why Government-Controlled Firms Avoid Taxes? Further Evidence

Why government-controlled firms avoid taxes has long constituted an enigma for both researchers and tax professionals. Tang, Mo and Chan (2017) provide an analysis to explain this puzzle from a corporate income tax perspective. This research extends the work of Tang et al. (2017) to validate their intergovernmental tax avoidance model from a value-added tax perspective and enhances the versatility of agency theory in explaining tax avoidance. In China, a large number of listed firms are controlled either by the central or local governments. Thus, governments play dual, but conflicting, roles as controlling shareholders of firms (who want to minimize tax expenses) and tax collectors (who want to maximize tax revenues).  As tax collectors, local governments who face budgetary pressures to cover welfare and other expenditures have strong incentives for discouraging firms from engaging in tax avoidance.  However, as the controlling shareholder of firms, these governments are the major beneficiaries from the after-tax returns on their investments in the firms that they control.  Thus, they possess a strong interest to direct their firms towards tax avoidance to maximize the resources under their control.  There is thus a conflict of self-interest. Since 2012, China has launched a landmark tax reform, replacing the business tax (BT) with a value-added tax (VAT) for all industry sectors (i.e., the Business-Tax-to-VAT Reform).  This reform will reduce the relevant tax burden on industries by approximately 10% (or approximately ¥500 billion) in 2016 (compared to 2015).  This tax reform has significant implications for tax revenue shared by local governments and the central government. Prior to the tax reform, 100% of the business tax (BT) collected belonged to the local government, whereas the VAT collected was shared in the ratio of 3:1 between the central and the local governments.  After the reform, funds collected through the VAT are to be equally shared between the central and the local governments, and there will be no BT. Due to this new requirement for sharing tax revenue, we expect that there will be an increase or a decrease in tax avoidance by government-controlled corporations, depending on the way that the tax sharing ratio changes for the respective government owners. This research project will examine the impact of this reform on intergovernmental agency conflicts and tax avoidance by government-controlled firms. Specifically, it will investigate how this tax reform affects the incentives of the relevant principals and agents in their tax-reporting decisions.