Journal Article
No. 2018-58 | September 14, 2018
Searching for profit-shifting in China

Abstract

This paper investigates profit-shifting behaviour among multinational corporations (MNCs) in China. The authors exploit the flat-rate structure of China’s corporate income tax, along with its system of targeted, preferential rates, to estimate the relationship between profits and tax rates. Their sample consists of approximately 60,000 observations of foreign-owned MNCs from the years 2005–2009. Using the traditional approach of regressing before-tax profits on tax rates, the authors find evidence consistent with profit-shifting. However, this approach is suspect because the nature of China’s tax preferences makes it especially vulnerable to omitted variable bias. Accordingly, the authors employ finite mixture modelling to search for the existence of a group of profit-shifting MNCs. While their analysis identifies two types of firms, subsequent investigation failed to produce any evidence linking these to profit-shifting behavior. Robustness checks exploiting the panel nature of the dataset, along with further investigation of investment-tax elasticities, confirm the authors´ null finding of profit-shifting. One reason for the lack of profit-shifting among Chinese MNCs may be that corporate tax rates were relatively low during this period.

JEL Classification:

F23, H32

Assessment

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Links

Cite As

Xuefeng Qian, Bifei Tian, W. Robert Reed, and Ziruo Chen (2018). Searching for profit-shifting in China. Economics: The Open-Access, Open-Assessment E-Journal, 12 (2018-58): 1–25. http://dx.doi.org/10.5018/economics-ejournal.ja.2018-58


Comments and Questions


Bifei Tian - Contributions and Notes
September 18, 2018 - 03:50

The contributions of our paper:
1) We follow the approach of Egger, Merlo, and Wamser (2014) and employ finite mixture modeling to search for the existence of a group of profit-shifting MNCs in China.
2) We perform robustness checks by estimating a fixed effects version of the finite mixture modeling, ...[more]

... and examining investment-tax elasticity rather than profit-tax elasticity.
3) In line with our analysis, our paper clearly states that we find no evidence of profit-shifting in China, at least over the period 2005–2009. One reason for the lack of profit-shifting among Chinese MNCs may be that corporate tax rates were relatively low during this period.

Some notes of our paper:
1) The previous version of our paper rightly called us out for claiming that our measure of effective tax rate was the same as Devereux and Griffith (1998), Devereux and Griffith (2003), and Egger, Merlo, and Wamser (2014). It is not. Their measure is forward-looking, while our measure is backward-looking. To avoid any confusion, our paper clearly defines our measure, and omits any discussion of D&G’s and EM&W’s measures of tax rates.
2) Our paper leads with, and focuses on, the relationship between PROFITS and ETR. This provides a much more direct measure of profit-shifting. We report our results on the relationship between ASSETS and ETR only as a robustness check. We still report results on the relationship between ASSETS and ETR, despite this being only an indirect test of profit-shifting, because this was the focus of Egger, Merlo, and Wamser (2014).
3) We do not have the data on “statutory rates for firms in different locations”. We have no statutory rates, and the tax law is expressed in sufficiently general terms that we cannot match firm characteristics to specific tax rates. For example, while we know that special economic zones received discounted rates, there is no numerical, firm location data in the data, and, even if there were, it is not possible to match location information to special economic zones. Further, as noted in Article 8 of Table 1, even this would not be sufficient to identify a firm’s applicable statutory tax rate because some firms were exempted from taxation during certain years. Unfortunately, there is no public record of firm-specific tax rates in China.