Trade Liberalization and Corporate Income Tax Avoidance

Abstract

We identify the effect of trade liberalization on corporate income tax avoidance in a sample of Chinese manufacturing firms, taking advantage of China's entry into the World Trade Organization (WTO). We find that firms engage in more tax avoidance in industries with larger tariff reductions. Further analysis shows that firms with a lack of cash or a high demand for cash before WTO entry tend to engage in more tax avoidance after WTO entry. Our study also provides evidence that manipulating costs is one way that firms avoid corporate income tax. (JEL D22, F61, F63, H26)

The effects of trade liberalization on tax avoidance

“…The larger tax differential induces more firms to shift their profits into the tax haven. Proposition 4 is supported by the empirical results of Wier and Zucman (2022), Gao et al (2019), and Chen et al (2022). Wier and Zucman (2022) report a rapid increase in global tax avoidance from the 1970s to 2015.…”

“…Wier and Zucman (2022) report a rapid increase in global tax avoidance from the 1970s to 2015. To explain the increasing trend, Gao et al (2019) suggest a mechanism from the viewpoint of a cash demand. They argue that in a more competitive environment caused by trade liberalization, the higher demand for cash prompts firms to engage in more tax avoidance.…”