Collusion, political connection, and tax avoidance in China

Our paper is the first to examine the impact of government‐firm collusion on firm tax avoidance in China by applying an instrumental variable approach. We take political turnover of local leaders as an external shock to the existing collusion and investigate firms' tax avoidance activities during local leadership transition. By using data on political turnover of prefectural leaders and listed firms from 2007 to 2014, we find that political turnover leads to the instability of existing collusion, and consequently a decrease in firm tax avoidance. This provides evidence of the pre‐existing collusion between government and firms. We then rule out the possibility that such change is driven by the effect of political uncertainty or tax competition by considering the heterogeneous effect of firms and cities. Finally, we show that firms' political connections, captured by political ties and ownership of firms, stabilize the existing collusion and help firms maintain their advantage while facing external political shocks.