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1670Despite the central government’s ongoing efforts to enhance tax reductions for small and micro enterprises (SMEs) in China, many eligible enterprises fail to benefit from these policies, which contributes to their persistently low tax compliance. The implementation of tax reduction policies relies heavily on the fiscal capacity of local governments. This paper examines how the fiscal capacity of local governments affects the implementation of tax reduction policies and, in turn, affects corporate tax compliance.
The results indicate that fiscal capacity constrains the implementation of tax reduction policies and consequently reduces the tax compliance of SMEs. Local governments with lower fiscal capacity may create complex application procedures that discourage eligible SMEs from applying for tax reductions. Moreover, applying for tax reductions increases the likelihood of tax audits, leading some SMEs to forgo the application to avoid potential scrutiny. In situations where tax reductions are not effectively implemented or accessible, SMEs tend to engage in tax evasion rather than applying for tax reductions, resulting in the observed decrease in tax compliance. Heterogeneity analysis reveals that these effects are more pronounced among SMEs with greater reliance on tax reduction policies.
This paper makes the following marginal contributions: First, it moves beyond the existing literature by shifting the analytical focus from the traditional ex-post assessment of economic consequences of tax reduction policies to the structural constraints during the policy implementation stage, providing insights into understanding why the effects of tax reduction policies exhibit regional heterogeneity. Second, it explores the specific mechanism through which local fiscal capacity affects policy implementation and subsequently affects corporate tax compliance, uncovering that fiscally constrained local governments tend to create complex application procedures and increase potential audit pressures, thereby discouraging enterprises from applying for tax reductions. Third, it suggests that enhancing the effectiveness of tax reduction policies depends not merely on providing more generous incentives, but critically on refining the central-to-local transfer payment system, simplifying administrative approval procedures, and standardizing tax enforcement behavior.
