Informal Tax Competition among Local Governments in China since the 1994 Tax Reforms

Abstract

This paper shows that tax competition among local governments in China takes place through informal means. One common form of informal tax competition in China is the tax refund: local governments compete for investment by offering to return a portion of tax receipts to firms. Through tax refunds, a considerable portion of reported local tax revenue has been returned to taxpayers` pockets. The prevalence of tax refunds suggests that the amount of tax revenue that local governments can use for public expenditure is much smaller than local tax collection data suggests. This study argues that the career interests of local political leaders are an important factor in determining the degree of lax competition. In China, the career advancement of local political leaders depends on their achievements in the cadre evaluation system. As the cadre evaluation system prioritizes the attraction of investment, local officials have strong career incentives to offer tax incentives in order to attract investment.