Smeal College of Business Taxation and Management Decisions: ACCTG 550Pennsylvania State University Professor HuddartTax Systems in Developing and Transition Economies1. Developing economies (e.g., China and Russia)1.1 Legal and accounting environment• rule of law not well-established in these jurisdictions• tax code changes frequently• GAAP is ill-defined• no binding precedents created by the court system• insufficient managerial or bureaucratic talent to implement and enforceany type of tax regime (e.g., sales tax, payroll tax, property tax, VAT,income tax)1.2 Consequences on industrial organization• State-owned monopolies charge high prices to consumers. The surplusis used to fund the national treasury.• If state-owned industries are sold, or if domestic competitors are allowedto emerge, then state profits from monopolies are eroded and treasuryreceipts fall.• Imported goods bear high tariffs. Exported goods may also bear hightariffs.1.3 Consequences on tax system• no or deferred income taxation for foreign investors• widespread tax evasion• regulatory emphasis on currency export restrictions to prevent repatri-ation of profits• taxation of transactions at the national frontiercSteven Huddart, 1995–2005. All rights reserved. www.smeal.psu.edu/faculty/huddartACCTG 550 Developing and Transition1.4 Foreign multi-nationals’ response• To avoid high tariffs on imports, the multinational undertakes produc-tion for the local market in the local market. This occurs even thoughsome developing economies are very small and economies of scale andscope suggest small developing economies should import the product.• To repatriate return on investment abroad, multinationals distort trans-fer prices on goods and services exchanged with the venture located inthe developing economies. High prices charged on import and low priceson export permit profits to be repatriated.Page