Trade Liberalization and Corporate Income Tax Avoidance

Abstract

We investigate the effect of trade liberalization on corporate income tax avoidance in a sample of Chinese manufacturing firms, using China’s entry into the World Trade Organization (WTO) as a natural experiment. We find that firms engage in more tax avoidance in industries with larger tariff reductions. We also find that firms with better corporate governance engage in less tax avoidance compared with their counterparts. 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 suggestive evidence that manipulating costs could be a way for firms to avoid corporate income tax.

Keywords: Trade liberalization, tax avoidance, WTO entry

JEL Classification: D22, F61, F63, H26