State ownership, tax status and size effect of effective tax rate in China

Political cost theory and political power theory are two views on the effect of firm size on effective tax rate (ETR) in extant literature. The size effect of ETR can be investigated further by focusing on the relationship between firms and the government. This paper uses state ownership and tax status to capture this relationship and examines how firm size, state ownership and tax status jointly affect effective tax rates. It is found that, when firms do not enjoy a preferential tax status, firm size is positively associated with effective tax rates for privately controlled firms and negatively associated for state-controlled firms. The results show that political cost theory explains the relationship between size and effective tax rate for privately controlled firms, whereas political power theory explains this relationship for state-controlled firms. For those firms that already enjoy a preferential tax status, there is no significant relationship between their size and their tax burdens.