Research Insights

Only the little people pay taxes?

By Dr. Fang Zhang

Only the little people pay taxes?

These famous words of billionaire Leona Helmsley – known as the Queen of Mean in the 80s – still ring true today. And in the aftermath of the Panama Papers revelations, ordinary people know that when it comes to taxes, we don’t all play by the same rules. Is the same true in China?

In a recent study1, Dr. Zhang and her team investigated whether politicians linked to a firm’s board had the power to mitigate, or even eliminate, tax enforcement effectiveness in the PRC. Creating a dataset combining the probability of an income tax audit, the expertise of tax officers, and the consequences of underreporting tax liabilities, the authors measured tax enforcement across 31 provinces, autonomous regions, and municipalities in China. Conclusion? Based on a sample of 11,121 firm-years between 2003 to 2013 a politically-connected board has the ability to significantly reduce the fear that understating taxable income might be detected and lead to heavy penalties. The authors also examine the shifting of income between member firms in a business group as it represents the most common tax avoidance strategy used in China. Again, political connections mean that certain firms don’t seem to fear the possibility of tax enforcement related to the use of this technique. The results suggest that better tax administration alone is not enough to increase government revenue. Tax policies should also take into consideration the political economy of tax enforcers. It is said that death and taxes are the only two certain things in life. But for many, it seems that when it comes to taxes, who you know still dictates how much you pay.

Reference:

1Lin, Kenny Z., Mills, Lillian F., Zhang, F., & Li, Y. (2017). Do Political Connections Weaken Tax Enforcement Effectiveness? Contemporary Accounting Research.

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