Are foreign firms favored in China? Firm-level evidence on the collection of value-added taxes

Abstract

Research has uncovered the so-called foreign-ownership bias in China – persistent and sizable policy-induced advantages conferred on foreign firms at the expense of domestic private firms. This article examines the presence of such biases in regulatory implementation, as revealed in the different actual value-added tax (VAT) incidence borne by foreign versus domestic firms. Using comprehensive Chinese manufacturing firm data, we find that within an industry, the de facto VAT rates facing foreign firms are on average 2 percentage points lower than those of domestic private firms. The finding of this “VAT discount” for foreign firms is robust to controlling for a host of firm characteristics and to using alternative definitions of foreign ownership. We rule out various economic motivations, such as the technology-seeking motive, and show indirect evidence that the ownership bias is intended to protect state-owned enterprises. Further research is needed to precisely pin down the underlying motivations and mechanisms.