DP1657 Taxes and Government Incentives: Eastern Europe vs. China

Author(s): Roger H Gordon, David Daokui Li
Publication Date: June 1997
Keyword(s): Government Incentives, Principal-Agent Models, Taxes and Economic Behaviour, Transition Economies
JEL(s): D78, H3, P51
Programme Areas: Transition Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1657

Local officials in China have strongly supported new non-state firms, yet other officials in transition countries have often strongly hindered them. We argue that a likely cause of these sharp differences in behaviour is differences in the source of government revenue. Local revenue in China came from profits and other taxes on new entrants, while elsewhere in transition countries tax revenue came disproportionately from the old state enterprises. All these officials can easily draw on public funds for personal use. As a result, local Chinese officials have a personal interest in encouraging the development of new firms, while other officials have a financial interest in suppressing new firms. To induce officials to be supportive of new firms, the model suggests raising the effective tax rate on them. Surprisingly, past work has ignored the role of the tax system in influencing the incentives faced by government officials.