The Trade-off between Tax Savings and Financial Reporting Costs: Public versus Private Firms in China

This study examines how public and private firms responded to the 2008 tax rate reduction in China from 33 percent to 25 percent. We find that private firms report significantly more income-decreasing accruals than public firms in 2007, prior to the tax rate reduction. These negative accruals are substantial and material both compared to public firms and compared to 2008. Private firms appeared to shift RMB 8 million in the aggregate, or 22 percent of total income. The results provide the first economy-wide estimates of the extent to which private firms respond materially to rate changes with inter-temporal income shifting.