Proposals are actively circulating in China to move to a unified enterprise tax structure with similar tax treatment of state-owned enterprises (SOEs), other private enterprises (OPEs) and foreign investment enterprises (FIEs). FIEs presently receive significant tax preferences through a sharply lower tax rate, tax holidays and other provisions. Here we use analytical representations of SOE behaviour, which differ from that of the competitive firm, to argue that a unified tax structure may not be a desirable tax change and that typically a higher tax rate on SOEs is called for on efficiency grounds. Using a worker control model with endogenously determined shirking, taxes on SOEs reduce shirking and a reduced SOE tax rate under a unified tax relaxes discipline on SOEs and losses result. Our results indicate a 0.26% of GDP welfare loss using 2004 data from a unified tax, and larger loss relative to an optimal tax scheme. Alternatively, if we use a managerial control model variant, we find a 0.19% welfare loss from a unified tax, and larger losses relative to initial higher SOE tax rates.

  • Li Wang is an Associate Professor of Economics at the Chinese Academy of
    Social Sciences (CASS). She holds an MA (1996) from the Graduate School of CASS, and a PhD (2005) from the University of Oldenburg, Germany. She is a Post-Doctoral Fellow (2006-2007) at the University of Western Ontario, Canada and a guest lecturer at Tsinghua University, China.