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| National Industrial Policy, Local Government Behavior and Effective Tax Rate: Theoretical Analysis and Empirical Evidence |
| GUO Jie, WANG Yucheng, ZENG Bohan
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School of Economics, Renmin University of China;
Department of Economics,University of Pittsburgh |
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Abstract For quite some time, national industrial policy in China has been a major policy instrument for macroeconomic regulation. The formulation and implementation of industrial policy is of great significance for the development of key strategic industries. A distinctive feature of China's industrial policy is the frequent interaction between industrial, fiscal, and monetary policies, forming a linkage mechanism. In most cases, fiscal and monetary policies are attached to industrial policies, resulting in their relative independence. This is key to understanding the effect of industrial policy and the macroeconomic regulation system in China, and also in interpreting industrial policy for high efficiency.
We investigate the causal relationship between national industrial policy and the fiscal and taxation policy of local governments. The contribution of this paper lies in absorbing the national industrial policy and the tax behavior of local governments into a unified analytical framework, and studying the role of local governments in implementing industrial policies through theoretical models.In additon, we focus on the changes in support of key industries from“Five-year Plan”, to identify the casual effect of industrial policy through micro data.
This paper studies the impact of national industrial policy on the effective tax rate of enterprises from the perspective of local government behavior. In our model, we treat the support of national industrial policy as a production factor, taking it into the production function of an industry. Based on previous studies, we anticipate that national industrial policy will lead to an increasing rate of capital return in the key industries via project investment and supporting policies. Local governments aim at regional economic development and increasing fiscal revenue, whose utility level depends on the gross production of all industries and unproductive consumption in the region. They have to make a tradeoff, given the support for key industries by national policy. On one hand, local governments can reduce the effective tax rate of key industries to attract more capital and increase gross production, and on the other, they can raise the effective tax rate of key industries to gain more fiscal revenue, with increasing unproductive consumption. Our theoretical analysis shows that industrial policy has led to an increased rate of capital return in the key industries, which imposes a tradeoff on local government between a tax reduction and a tax increase. When the local government tax rate is on the left side of the Laffer curve, the local government will reduce the effective tax rate of key industries.
Exploiting the national Five-Year Plan key industries to measure the industrial policies, we conduct an empirical test on the theoretical hypothesis.We find that industrial policy incentives significantly reduce the actual tax rate of the corresponding industries, and that the higher the local government fiscal revenue, the greater the decline in the effective tax rate. For industries obtaining ordinary support, the average decline in the effective tax rate is about 0.2 percent, while for industries obtaining key support it declines by 0.6 percent. Our analysis suggests that this results from reducing taxation for key industries. We further find that the reduction in the effective tax rate occurs mainly for private enterprises rather than local state-owned and central enterprises, partly due to the lower liquidity of state-owned capital. These findings are of great significance in understanding the role of local government in industrial policy and the coordination between industrial and fiscal policy.
This paper confirms the influence of national industrial policy on local taxation behavior, with the following policy implications. On the one hand, the behavior of local government are probably an important reason for the heterogeneous effects of national industrial policy. Thus, it is necessary to consider the influence of industrial policy on the incentive and capability of local governments, which impacts on policy implementation. On the other hand, the fiscal budget is another crucial constraint for industrial policy. We have to realize that the effects of industrial policy are much greater in regions with better economic development and more abundant fiscal resources than in other areas, which means that isolated industrial policies may broaden the gap in economic growth. It is thus of great importance to promote the coordination of industrial, fiscal, and monetary policy, such as introducing a preferential tax policy with a supportive credit policy to improve the efficiency of the industrial policy.
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Published: 29 April 2019
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