China’s experience with economic transition from central planning to a more market-oriented economy is unique, Vietnam being the only other country that most closely resembles China’s experience almost a decade later. Because of the gradualist approach adopted—Deng Xiaoping’s famous characterization of “feeling the stones to cross the river” —parts of the economy had remained unreformed at any time. This juxtaposition of reformed and unreformed parts of China would have created problems and incurred costs that may not have existed in a market economy that is equipped with strong institutions . At the same time, China was spared the pain that countries that subscribed to the “big bang approach” to use Vaclav Havel’s caption, “you cannot cross a chasm in more than one leap” that was principally undertaken by Russia (Bramall, 1995; Chang & Nolan, 1995). Indeed, China’s growth spurt stood in sharp contrast to Russia’s economic collapse when both countries liberalized (Ellman & Kontorovich, 1998).
The purpose of this book is neither to compare the experiences attendant upon these contrasting approaches nor to assess the merits of the Chinese approach to corporate tax management. Rather, the objective is to examine economic reforms that contributed to marketization and corporate tax management in China. To do so requires appreciation of economic reforms that have been undertaken since 1978 but especially from 1994. This is what the next section sets out to explain.
From Plan to Market
The story of China’s successful liberalization began by Deng Xiaoping in 1978 has been told many times. While this story began with the opening-up of the agricultural sector, much of the subsequent liberalization has been targeted at enterprises that saw the rise of the corporate sector. Economic reforms proceeded on several separate but interrelated tracks.
Ownership Reform
The first track is ownership reform that saw first greater autonomy given to state enterprises that dominated all production. Before 1978, the state controlled the whole economy; all enterprises were owned and managed by the state, with planned pricing instead of market pricing. Under this system, there was little incentive to perform. The earliest reforms were in corporate governance, but the limited success achieved by these partial reforms forced the government to introduce broader ownership reforms in 1993. That year saw the consolidation of the state enterprise sector, with many unprofitable state enterprises sold to private investors and large numbers of workers retrenched. In 1996, a policy of “grasping the large, letting go the small” was announced to reduce the size of the state sector, with the state retaining ownership and control of the largest state enterprises. Some state enterprises were also corporatized through the sale of equity to private interests in the Shanghai and Shenzhen stock exchanges set up in 1991–1992.
However, shares in listed enterprises were separated into tradable shares and non-tradable shares, with the state and “legal persons” (e.g., the state, statutory bodies, and corporations) holding the latter, effectively giving the government unchallenged control over listed enterprises despite dilution of state ownership. In contrast, tradable shares were open for trading in the Shanghai and Shenzhen Stock Exchanges owned by institutional and individual shareholders. However, this system was open to abuse in that the state in listed state enterprises could ignore the interests of tradable shareholders. To address this, another ownership restructuring occurred under the “split-share reform” in 2005 whereby non-tradable shares held by the state were converted to tradable shares the public can purchase in the stock markets. As the state reduced its ownership of enterprises, it retained control of what it considered to be the most important ones. This consolidation process also saw the size of state enterprises increase. Nevertheless, the non-state sector, consisting of local government collectives, private enterprises, and foreign companies, grew.
Institutional Reforms
The second track is associated with institutional reform. Institutions were defined by (North, 2005) as the “rules of the game” , and firms and organizations as the players who act by these rules. Like Coase (1937) and Williamson (1985), North (2005) considered markets to be the superior institution that left spaces for other institutions (both formal and informal) to correct market failure. However, following Rasiah (2011), in this book we accept markets, which refers to relative prices, as a critical institution but consider other institutions to not only play key roles at times, but also collectively solve coordination problems. Just as we need institutions to solve government failures, we also need institutions to check market failures (see also Zhang & Rasiah, 2015).
Given the early dominance of state enterprises, institutional reforms naturally began with these enterprises. In as early as the Third Plenary Session of the Eleventh National Congress in December 1978 , it was announced that the management autonomy of state enterprises would be expanded by linking managers’ performance to their rewards. The year 1984 saw the dissociation of state enterprises from the government and the separation of ownership rights and control rights. In January 1987, the contract responsibility system allowed managers to share part of the profits. In November 1993 , the Third Plenum Session of the Fourteenth National Congress of the Communist Party of China (CPC) set the target that enterprises would be legal entities in a modern enterprise system. Together with the corporatization of state enterprises, a corporate governance structure was adopted (see Qian & Wu, 2003). In that year, Chinese listed firms were to have a main board of directors and a supervisory board, the latter responsible for monitoring firm behavior (Dahya, Karbhari, & Xiao, 2002). However, unlike the German–Japanese model, a supervisory board in China had no right to appoint and evaluate managers. It was not until after amendment of the Chinese co...