On The Effect Of Enterprise Income Tax Reform On Capital Competition Among Local Governments

Since the reform and opening of China over the past decades, transition of decentralization induces local governments to favor economic growth and the strategic competition. This competition appeared regional protectionism under tax-contracted system, but evolved capture for tax base after the tax sharing reform. The objective of this paper is to discuss the mechanism between the local governments’strategic interaction and the evolution of decentralization. We use enterprises income tax which is close to capital competition, to test the change of the behavior of local governments on tax competition, due to the enterprise income tax reform over last decade.In this paper, we provide a spatial-econometric analysis of the change of local enterprises tax rate by using the cross-province panel data for1998to2012from China. We have found a strong evidence of tax competition appearing tax mimicking among local government. Higher enterprise income tax rates in other provinces lead to higher tax rates in its own community. The size of this effect diminished significantly at the first four tax reform, which points outs the tax competition among local governments has weakened. Due to centralization reform both in tax income and collection in2002, and the definition of new enterprise in2006, the usage of tax preference as a strategic tool was limited. The impact of tax reform is much more pronounced in2008. In contrast, the tax competition stopped to weaken since a reverse tax reform of decentralization in2009.We also investigate the incidence of the enterprise income tax reform in east, middle, western part of China. The evidence shows that only the tax reform in2002and2003influence the degree of tax competition in the east part. Whereas, the tax reform affects the degree strongly in middle part at each tax reform. In west part, none of the tax reform shows significant influence on tax competition among local governments.