Tax Enforcement and Firm Investment Efficiency: Evidence from Staggered Implementation of Tax Administration Information System

Abstract

This paper examines how increased tax enforcement accompanied by the new tax administration system impacts firm investment efficiency, exploiting the staggered implementation of the third phase of the Golden Tax Project (GTP III) in China. Consistent with the monitoring role of tax authorities (Desai et al., 2007), I find that firms improved their investment efficiency after the local tax office adopted the new system. This effect is more pronounced when tax authorities previously suffered from resource constraints, when the tax enforcement is further enhanced through local fiscal pressure, and when firms have a higher ex-ante propensity to avoid taxes. An analysis of the potential mechanisms of this investment efficiency effect reveals that increased tax enforcement serves as a substitute for corporate governance in that it has positive spillover effects on financial reporting quality and that investments are more responsive to market prices.