Tax competition among local governments: Evidence from the spillovers of location-based tax incentives in China

This paper exploits the tax incentives in China's Great Western Development (GWD) Program to identify tax competition among local governments. The reform reduces the statutory corporate income tax rate in GWD regions. Using this exogenous tax reduction as a quasi-natural experiment and adopting a difference-in-differences approach, we find that the reform in GWD regions leads to a 1.6328 percentage point decline in the effective corporate income tax rate and a 0.658 percentage point decline in the macro tax burden in non-GWD counties adjacent to the policy boundary. The results suggest that there are strategic interactions as well as a race to the bottom among counties in their tax setting. The results are stable across a series of robustness tests such as excluding other mechanisms of tax rate interaction and excluding the impact of other incentive policies in the GWD Program. Combined with the tax reduction effect in border GWD counties, we find that the tax interaction coefficient for the effective corporate income tax rate and macro tax burden between GWD and non-GWD counties along the border are 0.8718 and 0.3553, respectively. This reflects the intense tax competition among local governments in China. In addition, we demonstrate that tax competition mainly exists between geographically adjacent counties, as no such spillover effects are observed in non-GWD counties far from the policy boundary.