Why do countries bother taxing state-owned enterprises (SOEs)? This is a perplexing question, because governments that own profitable state enterprises could simply demand dividend distribution without taxing. When Professor Wei Cui started teaching in China in 2006 – one of the countries where taxation of SOEs is a uniform rule – his interest in the subject began to grow. Professor Cui’s research reveals that what China does is more of an international norm than an exception, and, based on this, he has now developed a new theory for the phenomenon.
Professor Cui’s explanation diverges from the two predominant approaches to the subject of SOE taxation. The first approach insists that for SOEs wholly owned by the government, taxing them makes no difference and is thus superfluous. A second approach is reflected in European constitutions and the EU treaty, and asserts that SOEs have to be taxed. The idea is that not taxing SOEs would be a form of discriminatory practice. SOEs would be at a competitive advantage compared to private enterprises, an impermissible government subsidy with regards to the unified EU single market.
Professor Cui argues that there are reasons why SOEs are taxed, but that they are not the reasons identified in the European context.
“SOEs need to be taxed, not because that is important to ensure neutrality but because SOE managers may have different goals and interests from their shareholders,” he explains. “In the scholarly literature, that is called an agency problem. Managers do not want to pay dividends, and private firms have to devise solutions that make managers distribute them. Some of the solutions usable for private firms do not work for public firms. In that case, taxing SOEs is a way of forcing distributions from state-owned enterprises.”
Professor Cui presents this research on SOE taxation in two interconnected publications, the first with a theoretical focus, providing an original economic analysis, the second a survey of existing literature that demonstrates empirical support for his new theory.
“SOEs are sensitive to taxation; they may respond to it just like private enterprises,” Professor Cui argues. While the empirical literature testing this hypothesis is still evolving, the more important point is that until now there has been no theory that is not obviously false as to why SOEs are taxed that can guide empirical research. Professor Cui’s work provides such a theory.
There are important implications for Canada and Canadian businesses in all of this. When a Chinese SOE invests in Canada, it is at a competitive disadvantage compared to private firms, which are taxed both at home and abroad. This is because SOEs get a lot of tax preferences at home, but receive none when they invest abroad. As a result, they may prefer to stay at home. However, host countries like Canada may choose to offer some tax preferences to foreign SOEs without fearing that this preferential treatment will destroy competition between private and state-owned enterprises.
Professor Cui’s project on SOE taxation is part of a broader interest in tax and development. His experience in China has convinced him that SOEs are critical for developing countries, making their taxation an important ongoing issue.
