How Well-Targeted Are Payroll Tax Cuts as a Response to COVID-19? Evidence from China

Numerous countries cut payroll taxes in response to economic downturns caused by COVID-19. This includes China, which completely exempted most firms from making social insurance (SI) contributions, resulting in an average tax cut of 21 percentage points on formal labor costs and approximately 20% of total tax remittances made by firms. We use novel data on 900,000 firms in one Chinese province to document new facts about the structure of SI in China and evaluate payroll tax cuts as a COVID-19 relief measure. We calculate that labor informality causes 54% of tax-registered firms---representing 24% of aggregate economic activity---to receive no benefits. Labor formality also increases with firm size, further skewing the benefit of payroll tax cuts towards large firms. But despite the mistargeting that results from these facts, the benefit of the tax cuts relative to firms' operating costs and liquidity is likely larger both for smaller firms and in industries most affected by the COVID-19 shock because these firms and industries are more labor-intensive.