Whack-A-Mole Effect: Social Insurance Policy and Tax Avoidance

This paper studies the relationship between social insurance policy and corporate tax avoidance behavior within the context of Chinese firms. Leveraging a comprehensive dataset spanning from 2007 to 2016, we find that firms with greater exposure to the 2011 social insurance law engaged in more tax avoidance activities following its promulgation. A one-standard-deviation increase in firms’ labor intensity corresponds to a 2.67 times of the sample median of the tax avoidance metric. This impact is amplified for firms with financial constraints, higher government ownership, ESG engagement, and those located in lenient tax enforcement areas. Through channel analysis, we show that the policy increases firms’ distress risk, stimulating them to use internally generated funds and adopt risky corporate strategies using tax avoidance. Our findings emphasize that legislation aimed at protecting employees unexpectedly results in corporate tax aggressiveness, which exemplifies the so-called whack-a-mole effect inherent in government regulations.