Social Security Taxation and Compliance : The Chinese Evidence

We study how payroll tax rate affects compliance in China's social security system, using natural within-city variations in statutory payroll tax rate over time for identification. Higher payroll tax rate reduces probability of participation in the social security system and ratio of taxable salary to total labor compensation. Elasticity of participation with respect to net-of-payroll tax rate is 0.31 and close to zero, and elasticity of taxable salary ratio 0.39 and 0.82 from individual and firm data respectively. The relative size of elasticities from the firm and individual analyses suggests that firms fail to register all their employees, particularly migrant workers. Indeed, we find that firms in regions with a relatively larger migrant population tend to underreport more in response to the payroll tax rate. Larger domestic private and foreign-owned firms show more compliance