Firms as Revenue Safety Nets: Political Connections and Returns to the Chinese State

Abstract

The political connection between the state and firms in the context of China's corporate restructuring has been little explored. Using the clientelist framework and unpacking the incentives of both firms and the state, we analyse political connections as repeated patron-client exchanges where the politically connected firms can help the state fulfil its revenue imperative, serving as a failsafe for local authorities to ensure that upper-level tax quotas are met. Leveraging original surveys of the same Chinese firms over an 11-year period and the variations in their post-restructuring board composition, we find that restructured state-owned enterprises (SOEs) with political connections pay more tax than their assessed amount, independent of profits, in exchange for more preferential access to key inputs and policy opportunities controlled by the state. Examining taxes rather than profits also offers a new interpretation for why China continues to favour its remaining SOEs even when they are less profitable.