2021, Paper: "We study tax enforcement in a two-sector economy and focus on cross-sector effect of sectoral shocks. Specifically, we investigate whether business fluctuation in mining sector can translates into volatile tax enforcement in non-mining sectors. A theoretical model suggests sectoral compositional change affect tax enforcement on all sectors in an economy with differential tax rates across sectors. Using the firm panel data from the Annual Survey of Industrial Production in China during 2000 and 2007, we instrument the value-added share of mining sector by employing customs prices of mining commodities. The 2SLS results show that the total effective tax rate of the non-mining sector rises as the value-added share of the mining sector falls, and vice versa. However, both the statutory tax rate of all firms and the macro effective tax rate of mining sector at prefecture level remain constant. The results are robust to two alternative measurements of tax enforcement – the effective VAT rate and the profit gap rate. The findings suggest cyclical sectoral tax enforcement spreads the risk from the mining sector to other sectors. In the end, we show that the uncertain effective tax rate leads to cautious effects that make firms’ decisions of investment and employment less responsive to demand shocks, resulting in greater cross-firm dispersion in revenue productivity and mis-allocation. The findings suggest that the volatile tax enforcement can be a mechanism underlying the resource volatility curse."
HKS Author - Jie Bai