Vulnerability to tax enforcement and spillovers of corruption: cross-industry evidence from China

Abstract

The article investigates the cross-industry spillover effect of tax enforcement and corruption. I propose a two-sector optimal tax administration model by incorporating vulnerability to tax enforcement (VTE) and corruption into the Allingham-Sandmo framework. Based on two large surveys of Chinese firms, I test the model by using industrial capital-intensity as a proxy for firms' VTE and exploiting turnover of prefectural secretaries of the Communist Party of China between 2000 and 2007 as a driving force of corruption. The findings suggest capital-intensive industries, which are vulnerable to tougher enforcement, pay higher effective tax rates, and, therefore, have stronger incentives to bribe in order to reduce their tax burden. The bribery produces negative spillovers that raise the effective tax rates of their labor-intensive counterparts. Further evidence confirms that older prefectural secretaries are prone to be corrupt and exhibit stronger tenure effects both on the effective tax rates and on firms' corruption expenditure (JEL H21, H26, H32, D22, D73).