Public versus Private Firm Responses to the Tax Rate Reduction in China

This study examines how public and private firms in China respond to the 2008 statutory tax rate reduction from 33 percent to 25 percent. Using a proprietary dataset of private firms, we find that private firms report significantly more income-decreasing current accruals than do public firms in 2007, the year prior to the tax rate reduction. These negative accruals were substantial and material, both compared with public firms and compared with 2008 accruals. By shifting their taxable income from a high- to a low-tax year, private firms save about 8.58 percent of their total tax expenses in 2007. Our results suggest that countries contemplating tax rate changes should expect material inter-temporal income shifting by private firms when they predict the short-term effects of changes in the tax rate on revenue.