Discussion Papers In Economics
And Business

The Incentive to Declare Taxes and Tax Revenue:
The Lottery Receipt Experiment in China
Junmin Wan
Discussion Paper 06-25

Graduate School of Economics andOsaka School of International Public Policy (OSIPP)
Osaka University, Toyonaka, Osaka 560-0043, JAPANThe Incentive to Declare Taxes and Tax Revenue:
The Lottery Receipt Experiment in China
Junmin Wan
Discussion Paper 06-25

September 2006

この研究は「大学院経済学研究科・経済学部記念事業」
基金より援助を受けた、記して感謝する。

Graduate School of Economics andOsaka School of International Public Policy (OSIPP)
Osaka University, Toyonaka, Osaka 560-0043, JAPANThe Incentive to Declare Taxes and Tax Revenue:
The Lottery Receipt Experiment in China∗
Junmin Wan†
Osaka University
September 1, 2006∗

This paper is a revised version of the chapter 8 of the author’s doctoral dissertation
for Osaka Uninvesity in December 2004.
†
The author would like to thank Kazuo Ogawa for his advice, guidance, and encouragement during the writing of this paper. The author is also grateful to Charles Yuji Horioka,
Shinsuke Ikeda, Wako Watanabe of Osaka University, Atsushi Kajii of Kyoto University,
Yaohui Zhao and Xuejun Liu of China Center for Economic Research (CCER) of Peking
University for their valuable comments. Thanks are also due to seminar participants at
Osaka University in 2004, and at Professor Yaohui Zhao’s research seminar at CCER on
22 June 2006 for their helpful suggestions. This paper was presented at 2004 Autumn
Meeting of Japanese Economic Association at Okayama University on 26 September 2004,
and the author gives thanks to Toshiki Watanabe (discussant) of Chuo University and theseminar participants for their useful advice. It was also presented at the ‘WTO, China,
and the Asian Economies, IV’ which was held by University of International Business andEconomics on 24-25 June 2006, and he gives thanks to Kevin Honglin Zhang (discussant)of Illinois State University, Caren Sureth of Universität Paderborn and the other seminar
participants for their helpful advice. The author gives special thanks to Jianhuai Shi of
CCER for his assitance for gathering data on tax revenues in Beijing. Any remaining
errors here are the author’s responsibility. Correspondence: (e-mail) wan@osipp.osakau.ac.jp (tel/fax) +81-6-6850-5839.

Abstract
We examine the validity of a new system of taxation called lottery receipts in China theoretically and empirically. Tax collection
is diﬃcult as the government diﬃcultly monitors the actual economic
dealings. To bring out the private information on transaction known
only to a seller and a buyer, the government has set up a lottery receipt
system which has been tried out in many areas. If the net revenue froma lottery receipt is invested in pure public goods, the lottery receipt
will been purchased even if the consumer has expected quasi-linear
utility. By issuing a lottery receipt, the government may prevent tax
evasion caused by conspiracies between consumers and ﬁrms and collect tax eﬀectively. Estimation is performed based on panel data fordiﬀerent periods from a total of 37 districts in Beijing and Tianjin during 1998-2003. The lottery receipt experiment has signiﬁcantly raised
the business tax, the growths of business tax and total tax revenues.

JEL classiﬁcation: H26, D81, D82
Keywords: tax evasion, business tax, lottery receipt experiment, random
trend (growth) model1

Introduction

1.1

The Light and Shadow of China’s Economy

China’s economy has shifted to a market economy since 1978 to include
the rural contract work system and private companies. Stock markets andspecial economic zones have been founded since the 1980s. In 1994, decentralization separated local and central government, including the taxation
system.1 After the 1978 shift to a market economy, high growth (averagely
9.6%) has been realized for 1979-2004 period. In 2005, China experienced
9.9% economic growth, and it is expected to achieve over 9% growth in2006. However, as shown in Fig. 1, the budget deﬁcit has become a serious
concern. The central government has been a budget deﬁcit since 1982, andthe ratio of budget deﬁcit to public expenditure was at the peak of −15.7%
in 2000.
Moreover, the Gini’s coeﬃcient which measures the degree of economic
inequality in China has shown a upward trend. The Gini’s coeﬃcient was
0.21 in rural sector and 0.16 in urban sector in 1978, 0.31 in rural sector and0.21 in urban sector in 1990, 0.37 in rural sector and 0.32 in urban sector in
2003. The nationwide Gini’s coeﬃcient was 0.39 in 1995, 0.40 in 2000 and
0.47 in 2004. Clearly, the degree of economic inequality in China is growing
and has reached a dangerous line.
To sustain future economic growth and stability, these two signiﬁcantissues must be resolved. The implementation of an eﬃcient and fair tax
1
From Fig. 1, the ratio of public income to GDP has changed to be in an upward trend
since 1994, it may be caused by this decentralization.

1

collection system might serve as an eﬀective and reasonable means toward
solving China’s economic problems; however, at present the country lacks
such a tax collection system. Economists have warned of the seriousness ofthe deﬁcit and inequality issues in China. In February 2004, Shiller (2004)
provided six pieces of advice regarding the Chinese economy, and his ﬁrst
recommendation was the creation of an eﬀective taxation system. Similarly,
Krugman (2004) noted that “since there is almost no tax collection systemanyway, a possibility that the China government itself will go bankrupt is
not zero, either.”

1.2

Tax Evasion

Although the government understands the importance of tax collection, withthe lack of the technical and intellectual ability to create a tax collection
system, all the eﬀorts would be a vein. To collect a business tax (similar
to a consumption tax, i.e., about ﬁve percent of total sales), income tax,
and wealth tax the government needs to obtain private and corporate ﬁnancial records of transactions, income, and wealth. However, unless thegovernment is willing to pay the signiﬁcant cost of monitoring the economic
dealings and the collection process, such information will not materialize.
Owing to the asymmetry of information between government and taxpayer,
individuals might be tempted to underreport the amount of taxes due.
Woller (1999) points that China’s shirking tax burden is partly due tonearly endemic levels of tax evasion. ‘So Taxing’ (1989) points that in 1989,
the tax authorities of Shanghai seized the books of 10,361 private businessmen and found that 8,953 of them had evaded tax. 86% of the 163,000
2registered businessmen in Shanghai (3.2% of the city’s workforce) may haveevaded taxes, probably 100% of the unregistered ones did. According to Li(1995), the tax evasion in China is estimated to have caused the governmenta loss of around 100 billion Yuan a year.
Fisman and Wei (2004) examines the relationship in China between the
tariﬀ schedule and the “evasion gap,” which is deﬁned as the diﬀerence
between Hong Kong’s reported exports to China at the product level andChina’s reported imports from Hong Kong. They have found that a onepercentage-point increase in the tax rate is associated with 3 percent increasein evasion.
Due to so serious tax evasion in China, it is diﬃcult for the government tocapture the real economic activity, thus there is a part of economy which can
not be counted into national accounting but become underground. Bajada
and Schneider (2005) ﬁnd that the size of the underground economy inaverage 1991-1995 and in average 2000-2001 in China are in 10.2% and13.4% of the oﬃcial GDP, respectively. Based on the ﬁrst census ‘China
Economic Census 2004,’ China National Statistical Bureau adjusted thenational accounting during 1978-2004 in January 2006. For example, theaccounting on GDP and on the service industry was undervalued to a large
degree, 14.39% of and 13.33% of GDP in 2004, respectively.2

2

The GDP was re-estimated based on the informaion including the number of nationwide employees. In 2004, the GDP was 15.99 trillion Yuan, but 2.3 trillion Yuan was
totally undervalued and of which 2.13 trillion Yuan was from the service industry.

3

1.3

Lottery Receipt Experiment

For many years mainland China has also been wrestling with the issue of
capturing a fair tax base. The government ﬁrst issued a guideline requiring“an oﬃcial receipt printed with public lottery number” (You Jiang Fa Piao,
in Chinese, hereafter we call it “lottery receipt”) as a means of organizing
tax collection. According to “The Act of China Taxation,” receipt is deﬁned
as a certiﬁcate of the monetary transaction, is the primary proof for ﬁnancial
accounting and a tax audit, and is managed with printing, issue, and storage
by the taxation bureau. The government incorporates a lottery ticket into
an oﬃcial receipt, hence the lottery receipt is not only an oﬃcial receipt
but also a public lottery ticket simultaneously. The system of requiring a
receipt with lottery transactions appeared in Taiwan in the 1960s, in orderto improve tax collection eﬃciency; Taiwan still uses this system today.
The mainland China central government ﬁrst mentioned on March 4,
1989, that the experiments with lottery receipt would be held in some areas
so as to strengthen the tax collection.3 Discussion and preparation took ten
years prior to the launch of the experiment. On January 1, 1998, the newreceipt system came into eﬀect in Haikou City, Hainan Province, which isone of the most open cities in China. The central government evaluated thesystem’s performance and has since increased the trial area incrementally
across the nation. According to the author’s May 2003 research using the3

See Note of Mainland China Government in 1989 for details. The original sentenceis written in Chinese, “State Council’s notice on the main points of economic reformpresented by State Commission for Restructuring the Economic System in 1989.” In thisnotice, it is pointed that “to strengthen the private ﬁrms’ tax collection, the lottery receipt
system can be tried out in some cities.”4

search engine Google.com, by the end of 2002 there were over 80 big-citylevel local tax bureaus countrywide (out of approximately 662) where theexperiment is underway. In other words, 12 percent of local tax bureaus are
conducting the lottery receipt experiment (LRE hereafter, also see Appendix
A).4
Accompanying the LRE, the “Act of China Taxation” was revised, andsince May 1, 2001, the “New Act of China Taxation” has been enacted.
The detailed enforcement rules for the new act came into eﬀect on October
15, 2002. A new 23rd article has since been added to the new act, which
provides that “the equipment which prevents tax evasion should be actively
installed.” Speciﬁcally, this “equipment which prevents tax evasion” is apatented machine that issues an oﬃcial receipt printed with a public lottery
number.5
The experiments were conducted in depth in three of China’s largest
cities: Beijing, Shanghai, and Tianjin. In Beijing, one district (out of 18)
has been conducting the experiment since January 1, 2001; seven districts
since August 1, 2002; and the remaining 10 districts have been issuing lottery
receipts since October 1, 2002. At ﬁrst, mainly service industries, such as
4

By the end of 2002, only Beijing and Shanghai had been experimental areas at theprovincial or state level, according to data from the China Taxation Bureau. Information
regarding the experiments in other areas has not been reported yet as formal statistical
data. The ﬁgure in Appendix A was obtained from the news media. Because these are notgovernment statistics, caution is required when interpreting the information. Therefore,
this table approximates the state of the experiments throughout country.
5
The inventor of the lottery receipt machine is Haiping DAI. He applied for a patenton April 28, 1998, and the China Patent Bureau authenticated the patent on February
21, 2001. This machine can issue the receipt with a special number that is used for arandom drawing. The value written on the receipt is reported to the consumer, the ﬁrm,
and the tax bureau simultaneously. The consumer can use the lottery receipt and thespecial number to investigate the status of the prize by telephone or via the Internet.

5

food service businesses issued lottery receipts. However, in Shanghai, theexperiment began in October 1, 2002, and since January 1, 2003, it has
grown to include other service industries such as beauty salons and realestate agencies. In Tianjin, Tanggu (one district of Tianjin) began theexperiment on January 1, 2003, and the other districts have started since
January 2004. Today, the scope of areas conducting the LRE has expanded
to many areas.

1.4

Contribution and Structure of this Paper

In this paper, we ﬁrst analyze theoretically whether the new taxation system
in China is well run, then we empirically examine the eﬀect of the new system on tax collection using the “natural experiment” method based on panel
data consisting of experimental and non-experimental areas. We found thatthe new system may work well, even if the consumer has quasi-linear preference and expected utility. In addition, we found that the lottery receipt
experiment has caused not only business tax revenues but also the growthsof business tax and total tax revenues to increase signiﬁcantly.
The structure of this paper is as follows. Section 2 presents related literature the inovation in China. Section 3 performs a theoretical consideration.
Section 4 describes the data, the model, and the method of econometric estimation. Section 5 shows the results, and Section 6 discusses the policy
implications and concludes.

6

2

Related Literature and Inovation

2.1

Related Literature on Tax Evasion

Allingham and Sandmo (1972) and Yitzhaki (1974) are pioneers in analyzingthat a risk-averse taxpayer choose an optimal unreported income to maximize the expected utility under the governmental auditing. Since then there
are enormous theoretical and empirical studies on tax evasion. Andreoni etal. (1998) make a comprehensive survey of this literature. It has been theoretically found that the tax enforcement, auditing, tax rate, income level andsocial norms etc. should have impacts on tax evasion. Chapter 2 of Cowell(1990) makes a list for the empirical studies of the extent of tax evasion
and the black economy in nineteen major countries. Crane and Nourzad(1994), O’Higgins (1989), and Alm et al. (1991) emprically examine thedeterminants of income tax evasion in U.S., U.K, and Jamaica, respectively.
As pointed out by Ishi(1981), there is the issue of ‘kuroyon’ in Japan,
which refers to the fact that the capture rates of taxale income recorded forsalaried workers, farmers and the self-employed are about 90, 60, and 40
percent, respectively. The taxation issue is often a point of contention in
Japan and it has been studied for many years. In relation to the ‘kuroyon
issue,’ as discussed in Horioka and Sekita (2006), it has been hotly debatedin Japan whether a corporate enterprise tax system based on sales, salary,etc., and a taxpayer numbering system should be introduced; however, thisargument does not progress easily.

7

2.2

Inovation in China

Up to date, the researches on tax evasion has been focused on the eﬀects ofgovernmental monitoring, punishment and consumer’s attributes on the tax
evaders. It is the ﬁrst time that the LRE in China has been tried to givethe taxpayers’ incentive to voluntarily declare the tax base by not inﬂicting
punishment but giving a prize (public lottery) simultaneously. There still
have been neither theoretical nor empirical research on this new system.

3

Theoretical Framework

3.1

Purchase of Lottery

Morgan (2000) presentes a mechanism for ﬁnancing public goods by meansof a taxable lottery for consumers with quasi-linear preferences. Morgan(2000)’s mechanism is proved to be more eﬃcient than a voluntary taxpayer
system in regard to raising funds for welfare improvement. Morgan andSefton (2000) further conﬁrm this theory by experiments. Prior to thesestudies, Friedman and Savage (1948) and Kahneman and Tversky (1979)
analyze lottery purchases; however they do not consider the issue of producing an oﬃcial receipt with lottery as a way to track business tax.

3.2
3.2.1

Tax Declaration by Lottery Receipt
Tax Evasion due to Too High Monitoring Cost

In an economic transaction (without lottery), it is assumed that there arethree types of agent: the ﬁrm, the consumer, and the government. The gov-

8

ernment does want to know the transaction volume between the ﬁrm andthe consumer to collect the business (sales) tax. It is assumed that there areinﬁnite homogeneous ﬁrms, and that these ﬁrms seek proﬁt maximization
within a competitive market. It is also assumed that there is a suﬃciently
large and homogeneous body of consumers. When a consumer buys a product from a ﬁrm, the information on the purchased quantity “v” is sharedwith the company. The government cannot know about this sale unless it
applies a suﬃciently large monitoring cost. Although social public welfare
will increase if all consumers pay their taxes voluntarily to produce optimal
public goods, the consumer has an incentive not to pay taxes (free rider
incentive) because the government cannot supervise the trading volume between the consumer and the ﬁrm. It is assumed that the government collects,
to the highest extent, sales tax “x” according to the purchased amount “v”(here the rate of business (sales) tax is “x/v”), but that it cannot perform
proper accounting unless it has correct information regarding the correct
amount of “v.” However, the cost of monitoring “v” is larger than the tax
revenues “x” and the information value of “v.”6 Therefore, the government
will not act as the monitor of “v” and cannot fully collect the tax “x.”3.2.2

Issuing and Purchase of Lottery Receipt

From the above section we know that the government’s net tax revenue will
be zero if the monitor cost is larger than the tax “x.” Therefore, whenbuilding a tax collection system, a government must try to make taxpay6
The information value of “v” here means that the correct value of “v” is essential to
the national accounting.

9ers cooperate in providing accurate ﬁnancial information and must try todesign and provide an incentive mechanism that can mitigate information
asymmetry. Here, the government is assumed to issue a lottery receipt togather the information on sales.7
Something like money or currency, the lottery receipt cannot be forged.
When a consumer obtains a lottery receipt printed with the purchasedamount “v,” this receipt with “v” is copied into the government (to get
receipt means that the consumer declares the volume “v” and the tax “x”),
thus the government receives the veriﬁable fact of “v” and can collect the
tax “x.” Consumers have probability of getting lottery prize from the government if they are in possession of the lottery receipt. The lottery receipt
is essentially a public lottery, but it has some diﬀerences from regular publiclottery. First, it is printed on an oﬃcal receipt. Second, its price is thesales tax “x.” Fig. 2 shows the framework of the delivery of lottery receipts
among the government, the ﬁrm, and the consumer.
Accordingly, we can transfer the consumers’ purchase problem of a lottery receipt into a purchase problem of pure public lottery. We analyze theconsumers’ purchase of lottery tickets using Morgan (2000)’s framework.8
In this framework, the government sells ﬁxed-prize raﬄe tickets (the prize
amount is “R”) and informs each consumer of “R” in advance. Consumeri has wealth wi and quasi-linear preference. There are N consumers in this7

In reality, the goverment mornitors the tax evaters at the same time, issues lottery
receipt. For simplicity without lossing generality, it is assumed that the government does
not make monitoring. Another reason for this assumption is that there are not any dataon the governmental monitoring in the empirical analysis.
8
The author also analyzed the purchase of public lottery in the framework of Kahneman
and Tversky (1979) and Guiggin (1991) and found the second order condition for the
optimal lottery for government. The detailed results are available upon request.

10

economy. Consumer i optimally chooses the amount to purchase xi ∈ [0, wi ],conditional on the fact that the purchases of other consumers are given. The
probability of winning the prize is set to xi /x(N ) (x(N ) = x1 +...+xN ). The
net revenues to the government for oﬀering pure public goods is G=x(N)-R.
The sales x(N) of the lottery are assumed to be large enough to cover the
prize R. The problem of lottery purchase for consumer i can be set as thefollowing expected utility maximization:
EUi = wi − xi + [xi /x(N )]R + hi [x(N ) − R],(1)where hi is consumer i’s utility from pure public goods. The ﬁrst ordercondition with respect to xi is[xi /((x(N))2 ]R − 1 + hi [x(N ) − R] ≤ 0.

(2)

In equilibrium, N’ consumers will purchase the amount (x∗i , ..., x∗N  ) of lottery tickets, respectively. If the ﬁrst order conditions of N’ consumers areadded, we get


N

i=1

hi [x∗ (N  ) − R] − N  + (N  − 1)[R/x∗ (N  )] = 0.

(3)

When the prize R is increased, the eﬀect of prize R on the lottery sales x∗

11and on the net government revenues, respectively,9 are∂x∗ (N  )≥ 1,∂R∂x∗ (N  )∂G=− 1 ≥ 0,
∂R
∂R

(4)
(5)

with strict inequality provided N  >1. As shown in equations (4) and (5),increasing the prize does not reduce the sales x∗ and the governmental net
revenue G, but it is unclear here whether the prize deﬁnitely increases G.
Hence, it is necessary to clarify this property empirically.
We can consider that R=0 in areas where the LRE is not being conducted; thus Equation (5) can express the diﬀerence in tax revenues between
areas where the experiment is and is not being conducted. Moreover, comparison within the areas of the experiment is also possible, and according toEquation (5), the tax revenue in areas of the experiment with large prizes
is likely to be larger than (or equal to) that in areas of the experiment withlower prizes. Sections 4 and 5 examine the eﬀect of the lottery receipts, inother words, whether ∂G∂R ≥ 0 is true.

4

Empirical Examinations

4.1

Probability of Winning a Prize, Amount of Prize

To announce the amount of the prize beforehand can be considered a strategy of the government. For example, according to the pre-draw prize announcement by the Beijing Local Tax Bureau on July 17, 2002,10 total prize9
10

See Morgan (2000) for details.
See “Beijing Evening on July 17, 2002” for details.

12money amounted to three million Yuan in August and September, and 10
million Yuan between August and December in 2002. However, ex post
facto, the total prize money paid out to the 67,129 winners in the whole
city during 2002 was 1.67 million Yuan. The total actual prize was therefore
only 16.7 percent of the announced prize.11 Moreover, the pre-drawing prizeannouncement of the probability of winning the prize (namely, the ratio between the prize and the tax revenue) may be a strategy of the government.
According to a report of the China Taxation Bureau on July 30, 2002,12
the total prize amount paid out in all of the experimental areas throughout
China was 30 million Yuan, and the increase in tax revenues brought about
by the lottery receipts was 900 million Yuan between January 1 and June30, 2002. The ratio of the prize to tax revenues (which can be seen as a kindof input output ratio) was about 1:30. In the experiment in the Huairou
District of Beijing in 2001, 0.14 million Yuan was paid out in prizes and thetax revenue of six million Yuan was increased owing to providing a receipt
with lottery purchases. The prize tax revenue ratio was about 1:40. Many
Chinese mass media outlets announce information regarding the prizes. We
cannot obtain detailed information on prizes at the provincial or state level
for the entire country, thus we cannot perform an econometric analysis at
the provincial level.
There are 18 districts in Beijing. Huairou, Chaoyang, Shunyi, Fengtai,
Fangshan, Pinggu, Shijingshan, and Miyun have issued receipts with lotterytransactions since August 1, 2002. The other ten districts began issuing
1112This may also be because the planned sale of lottery x* was not realized.
See ‘People’s Daily’, July 31, 2002 for details.

13receipts on October 1, 2002. Therefore, the eﬀect of the experiment on tax
revenues can be estimated by district-level panel data (18 districts, 6 years,
before and after the experiments).
One district of Tianjin, Tanggu has issued the receipt with lottery since
January 1, 2003. The other districts of Tianjin have issued receipts withlottery purchases only since 2004. Tianjin is adjacent to Beijing both geographically and culturally. They are both cities under the direct control of
the central government. According to Table 1, the populations, city scale,and income of these two cities are very similar. Therefore, we used Tianjin asa control area for a comparative analysis of before and after the experiments
in Beijing.

4.2

The Data Set

We obtained detailed information on the experiments, such as prize amounts
and tax revenues, from the Tianjin Statistics Bureau, Tianjin Tax Bureau,
Beijing Statistics Bureau, and Beijing Tax Bureau. Beijing Statistics Yearbook 1999-2004, Tianjin Statistics Yearbook 1999-2004, Beijing Public Finance Statistics Yearbook 2002-2004 and China Statistics Yearbook 19992004 are used. Therefore, we used the 6-year (1998-2003) district-level data
(18 districts in Beijing and 21 districts in Tianjin) to empirically examine
the eﬀect of experiment.
The information on prize reported by mass media or estimated by theauthor,13 is shown in Appendix B. In Tanggu of Tianjin, the prize was 75,800
13

The author has used the prize reported by mass media to estimate the prize in the
period without reporting by weighted average. The detailed information is available uponrequest.

14

Yuan in 2003.
The deﬁnitions of variables are described in Appendix C. Summary
statistics of the data are reported in Table 2. The main information before and after the experiments is summarized by district in Table 3. These
two tables provide some indication of the eﬀects of the experiment.

4.3

Empirical Specification and Estimation Method

Following Heckman and Hotz (1989), Papke (1994) and Wooldridge (2002),
we used the following empirical models to capture the eﬀect of the experiments (Equation (5)), and ﬁrst obtained a random trend model,
yit = ci + βLREit + γZit + gi t + uit ,(6)

where yit is the level value of per capita real business tax revenue in district i,
LREit is the information on experiment, Zit are the controlled variables withlevel values, gi is the speciﬁc trend in the district, ci is the speciﬁc timeinvariant factor, uit is the white noise. ci , gi and uit are all unobserved.
When yit and Zit are log values, Equation (6) becomes a random growthmodel.
The ﬁrst diﬀerence of Equation (6) becomes∆yit = β∆LREit + γ∆Zit + gi + ∆uit .

(7)

For a consistent estimator of β, the important condition is that the LREit isexogenous. As pointed out in Heckman and Hotz (1989) and Papke (1994),

15

if there is a problem of self-selection regarding program participation, it isvery hard to obtain a consistent estimator of β. Here, there are three reasons
to bring LRE close to be exogenous. Firstly, there are many preparations
that must be made before the LRE starts. The timing of LRE is mainly
determined by the degree of the preparation. Secondly, as everyone knows,
China is a centralized country, and policy changes cannot occur in a state ora city unless the central government grants permission; moreover, no state orcity has the freedom to accept or reject central government policy. Thirdly,
because all of the samples used in the econometric analysis are areas thatparticipated in the experiment, by using experiment information for diﬀerent
periods we can avoid the problem of serious self-selection and tend to obtaina consistent estimator of the eﬀect of the experiment. Therefore, it canreasonably be said that LREit is exogenous to a large degree.
Because error term ∆uit is the one diﬀerence of uit , it becomes a seriescorrelation.14 The ﬁxed eﬀect of panel estimation considering this characteristic of the error term is used to estimate Equation (7). This method
is the ﬁxed eﬀect within regression with AR(1) disturbances explained indetail in Papke (1994) and Wooldridge (2002).

4.4

Variables used in the Empirical Tests

The methods of making the variables for estimation are summarized in Appendix C. ∆yit is the one diﬀerence of yit which is the level or log valueof per capita real business tax revenue in district i and is the dependent
variable. ∆LREit is the dummy variable for an experiment district (1 for
14

Corr(∆uit , ∆uit−1 ) = −0.5. See page 283 of Wooldridge (2002) for details.

16

an experiment district, 0 for others) multiplied by the dummy variable forthe experiment time (1 for experiment time, 0 for other time).15
To obtain a diﬀerence in diﬀerence estimator for β, Huairou in Beijing
and Tanggu in Tianjin are dropped from the sample, because Huairou andTanggu have diﬀerent timing of LRE compared to other districts.16 Thus,
we ﬁnally use a data set of 37 districts for 6 years.

5

Estimated Results

Table 4 is the result of panel estimation based on the information for 17
districts in Beijing (excluding Huairo) and 20 districts in Tianjin (excluding
Tanggu). The dependent variables are the ﬁrst diﬀerences of the level andthe logarithm of business tax and total tax revenues, and the independent
variables are the ﬁrst diﬀerences of LRE, GDP, GDP of the 2nd sector and
GDP of the 3rd sector; thus the value of the estimated coeﬃcient of ∆LRE
serves as the diﬀerence in the level between experiment and non-experimentareas. For business tax revenue, the coeﬃects of ∆LRE are signiﬁcant,ranged from 84.355-105.676, and the elasticities of experiment is from 0.171
to 0.213. In the case of total tax revenue, the eﬀect of the experiment is not
signiﬁcant, although the coeﬃcient is positive. These results imply that theexperiment has signiﬁcantly raised business tax revenue by over 17.1 percent

15∆LREit is the independent variable. ∆P rizeit is the one diﬀerence of per capita reallottery prize; it is considered a proxy for capturing the experiment eﬀect (∆LREit ) andis an independent variable.
16
The estimation results are almost unchanged when Huairou and Tanggu are includedin the sample, and these results are also available upon request.

17

but has no signiﬁcant eﬀect on total tax revenue.17
Table 5 shows the results of panel estimation based on the information
for the 17 districts in Beijing and 20 districts in Tianjin. The dependent
variables are the ﬁrst diﬀerences of logarithm of business tax revenues andtotal tax revenues, and the independent variables are the ﬁrst diﬀerencesof LRE, logarithm of GDP, GDP of the 2nd sector and GDP of the 3rd
sector; thus the value of the estimated coeﬃcient of ∆LRE serves as thediﬀerence in the growth rates between experiment and non-experiment areas.
For business tax revenues, there was about a signiﬁcant 21.5-24.2 percent
increase in the growth rates of the experiment areas. In the case of total
tax revenue, there was a 10.4-11.6 percent increase.18

6

Conclusion

The literature on tax evasion has been focused on the eﬀects of governmental
monitoring, punishment and consumer’s attributes on the tax evaders. It is
the ﬁrst time that the LRE in China has been tried to give the taxpayers’
incentive to voluntarily declare the tax base by not inﬂicting punishment
but giving a prize (public lottery) simultaneously.
This paper examined, theoretically and empirically, the eﬀect of LRE on
17

The author also has used the ﬁrst diﬀerence of prize as a proxy for ∆LRE, but he has
not obtained signiﬁcant eﬀect from prize. There may be two reasons. First, the amountof prize is determined by the sales simultaneously thus it is endogenous. Second, the dataon prize is not statistical data but estimated by the author, thus there would be large
measurement error on the prize data. These estimation results are also avalaible uponrequest.
18
The author also has used the ﬁrst diﬀerence of prize as a proxy for ∆LRE , but has
not obtained signiﬁcant eﬀect from prize. Same reasons as in Footnote 17 are considered.
These results are also avalaible upon request.

18

tax revenues (implicitly on tax evasion) in China. When the revenue fromthe public lottery printed on an oﬃcial receipt is used to ﬁnance the public
good, even if a consumer has expected utility with quasi-linear preference,he or she will purchase a lottery receipt. By issuing lottery receipt, the Chinese government can prevent the tax evasion caused by collusion between
consumers and ﬁrms and can collect business taxes eﬀectively to some extent. Our empirical examination of 6-year data from 37 districts in Beijing
and Tianjin indicated that business tax revenue was signiﬁcantly (over 17.1
percent) higher, and the real growth rates of business tax and total tax revenues were signiﬁcantly (over 21.5 and over 10.4 percent, respectively) higher
in experiment areas than in non-experiment areas. Moreover, because thedata sets used were from all of areas that participated in the experiments,
and because the estimations were based on diﬀerent periods of participation,
self-selection problems were avoided to a large degree. Thus, our analysis issimilar to a kind of (quasi) natural experiment.
The Chinese economy in the 20th century was quite experimental; forexample, there was the socialist economy experiment, the market economy
experiment, and the experiment with lottery receipts. By means of theseexperiments, the Chinese economy has both stagnated and grown. Although
it is natural that some experiments will fail to an extent, it is obviously
necessary to avoid failure if possible. Through the analysis of the data sets
conducted in this study, the LRE can be judged as successful insofar as
it increased business tax revenues and the growths of business and total
tax revenues. Certainly, this new system of taxation will have a signiﬁcant
inﬂuence on future tax collection policies in China, and perhaps in other19

countries as well.
In future research, we must clarify theoretically and more speciﬁcallyconsumer preference for lottery ticket purchases and empirically apply thosedata to the information from the experiment and non-experiment areas for2004. Moreover, we must obtain nationwide information and perform detailed analyses based on individual data, including attitudes toward thelottery receipt system.19 Additionally, because playing the lottery is a formof gambling, we must consider the social cost of gambling in relation tosocial welfare.20

19

Aanlysis based on individual data has been a research project of Center of Excellence
program in Osaka University. The ﬁrst survey on 1,500 Chinese households was performed
in March 2006. The author is making econometric analysis using this micro data set.
20
However, the tax evasion is penalized in every country when it is dectected by government, thus the tax evasion is also a form of gambling.

20

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23

Figure 1: Budget Deficit, Public Income andTax
Revenues in China, 1951-2004
0.4
0.3
0.2

Ratio of budget
deficit to public
expenditure

0.1

Ratio of public
income to GDP

0

Ratio ofbusiness tax tototal tax
revenue-0.1

Source: China Statistics Yearbook, 1991-2005

2003

1999

1995

1991

1987

1983

1979

1975

1971

1967

1963

1959

1955

1951

-0.2

Figure 2: The Delivery of the Receipt with Lottery in China
consumers get prize from government

receipt with lottery

government

goods and receipt with lottery

firm

tax based on the receipt with lottery

Source: drawn by author

consumermoney (transaction)

Table 1: Main Indicators in Beijing and Tianjin
in 2002

2002
PopulationGDP
Per capita GDP
Growth rate of per capita GDP
Total tax revenues

Beijing

Tianjin14.253 million

9.191 million

321270 million Yuan

205120 million Yuan

22541 Yuan

22380 Yuan

0.08

0.11

53400 million Yuan

37590 million Yuan

Source： Beijing Statistics Yearbook 2003, Tianjin Statistics Yearbook 2003

Table 2: Descriptive Statistics
Variable

Obs

Mean

Std. Dev.

Min

Max

tax̲revenue
business̲tax
gdp
second̲sector̲gdp
third̲sector̲gdp
population
cpi
prize
real̲revenue
real̲business̲tax
real̲gdp
real̲secondary̲gdp
real̲third̲gdp
real̲prize
experiment

222
222
222
216
215
222
222
222
222
222
222
216
215
222
222

70325
27715
1137669409171612835
54
102
53790
1488
495
28483
9243
11060
0.066
0.2

97262
43139
1363700
52814893989433
3255712
2322
547
52473
19429
14153
0.235
0.361

8227
1617
109560
10879
44177
5
99
0
191
38
1810
249
1507
0
0

560802245595892895035489926930939178
1072459359
16869
3023
446171
1519371136451.5
1log̲revenue

222

6.797

0.903

5.253

9.733

log̲business̲tax

222

5.736

0.962

3.634

8.014

log̲gdplog̲second̲gdp
log̲third̲gdp
after
LRE
ΔLRE

222
216
215
222
222
185

9.652
8.418
8.874
0.333
0.153
0.092

0.965
1.179
0.853
0.472
0.361
0.290

7.501
5.519
7.318
0
0
0

13.00811.93111.6411
1
1

Δ Total tax revenue

185

198

490

-2300

3884

Δ Business tax revenue
ΔGDP
ΔGDP of 2nd sector

185
185
180

72
4593
1120

136
11585
2944

-332
-1569
-5249

853
10072620468

ΔGDP of 3rd sector

178

1690

2723

-561

20976

Δreal̲prize

185

0.067

0.215

0.000

1.232

Δlog(Total tax revenue)

185

0.153

0.194

-0.2740.827

Δlog(Business tax revenu

185

0.136

0.269

-0.774

1.604

Δlog(GDP)

185

0.150

0.065

-0.1340.481

Δlog(GDP of 2nd sector)

180

0.114

0.206

-0.6921.276

Δlog(GDP of 3rd sector)

178

0.155

0.069

-0.103

0.388

Source: Author's calculations based on Beijing Statistics Yearbook, 1999-2004, Tianjin Statistics
Yearbook, 1999-2004, and Beijing Public Finance Statistics Yearbook, 2002-2004.

Table 3: The Growth Rate of Per Capita Tax Revenue inBeijing and Tianjin Before and After the ExperimentDistrict

Time

Variable

Obs

Mean

Std. Dev.

Min

Max

Δlog(Businesstax revenue)

51

0.134

0.280

-0.4910.712

Δlog(Total tax
revenue)

51

0.229

0.181

-0.1240.688

Δlog(Businesstax revenue)

34

0.263

0.273

0.006

1.604

Δlog(Total tax
revenue)

34

0.170

0.190

-0.2460.794

Δlog(Businesstax revenue)

60

0.142

0.167

-0.1630.757

Δlog(Total tax
revenue)

60

0.152

0.134

-0.2740.540

Δlog(Businesstax revenue)

40

0.020

0.328

-0.7740.505

Δlog(Total tax
revenue)

40

0.043

0.240

-0.232

0.827

before 2002
Beijing(excluding
Huairou)
2002, 2003

before 2002

Tianjin(excluding
Tanggu)2002, 2003

Source: Author's calculation based on the processed data.

Table 4: The Effect of Lottery Receipt Experiment (LRE) on Tax Revenues(Random Trend Model, 37 Districts in Beijing and Tianjin, 1998-2003)
Dependent variable = ΔBusiness tax revenue

ΔLTE

Fixed
EffectElasticity

Fixed
EffectElasticity

Fixed
Effect105.6760.213

102.4160.207

84.355(36.758)

***

ΔGDP

(36.289)
0.004(0.002)***(36.915)**

Dependent variable = ΔTotal tax revenue

Elasticity

Fixed Effect

Fixed Effect

Fixed Effect0.171

118.031115.324

94.548(133.737)(134.142)(139.782)

0.006(0.007)**

ΔGDP of 2nd Sector

0.013

0.039
(0.023)

ΔGDP of 3rd Sector(0.006)**0.025
148.455-0.010(0.041)140.912(52.278)***(72.504)***

Constant

44.496(11.970)***

30.786(13.901)**(0.010)-2.808178.03(19.476)(46.812)***

Observations
Number of groups

148

148

142

148

148

142

37

37

36

37

37

36

R-sq: within
between

0.070
0.166

0.101
0.117

0.165
0.257

0.070
0.105

0.013
0.294

0.032
0.073

0.098

0.121

0.194

0.010

0.044

0.037

-0.147-0.164-0.176

0.352

0.349

0.347

overallrho̲arNote: Standard errors are in parentheses; *, **, *** denote significant at the 10%, 5% and 1% levels, respectively.

Table 5: The Effect of Lottery Receipt Experiment (LRE) on Growth Ratesof Tax Revenues(Random Growth Model, 37 Districts in Beijing and Tianjin, 1998-2003)
Dependent variable = Δlog(Business tax revenue)
Fixed Effect

Fixed Effect

Fixed Effect

Fixed Effect

Fixed Effect

Fixed Effect

0.234

0.242

0.215

0.109

0.116

0.104

ΔLTE

(0.083)***Δlog(GDP)***(0.085)-0.255(0.470)Δlog(GDP of 2nd Sector)
Δlog(GDP of 3rd Sector)
Constant

Dependent variable = Δlog(Total tax revenue)

0.080(0.027)

***

0.112

(0.095)**(0.055)***(0.056)-0.206(0.312)(0.062)*0.041-0.031(0.151)(0.099)0.113(0.514)
0.058

0.160

0.112
(0.334)0.109(0.046)***(0.052)**0.130(0.070)(0.083)(0.018)***Observations
Number of groups

148

148

142

148

148

142

37

37

36

37

37

36

R-sq: within
between

0.067
0.114

0.076
0.072

0.061
0.101

0.034
0.149

0.038
0.024

0.035
0.140

0.080

0.076

0.071

0.044

0.030

0.042

-0.068-0.070-0.070

0.085

0.092

0.101

overallrho̲arNote: Standard errors are in parentheses; *, **, *** denote significant at the 10%, 5% and 1% levels, respectively.

Appendix A: The Areas with Lottery Receipt
Experiment (LRE) in China in 2002
(author's search using the search engine Google.com in May 2003)

Nationalwide
Beijing
Tianjin
Hebei
ShanxiNeimenggu
Liaoning
Jiling
Heilongjiang
Shanghai
Jiangshu
Zhejiang
Anhui
FujianJiangxi
Shandong
Henan
Huben
Hunan
Guangdong
Guangxi
HainanCongqing
Sichuan
GuizhoYunan
Xizhuang
Sanxi
GanshuQinghai
Ningxia
Xinjiang

number of districts
or cities

number of districts(cities) with lottery
receipt experiment

the rate of lottery
receipt experiment(percent)

2858
18
18
172
119
101
100
60
130
20
108
88
106
84
99
139
158
101
122
122
110
20
40
180
86
128
73
107
86
43
24
96

228
18
0
16
0
0
28
5
11
20
0
0
4
13
18
25
7
13
9
26
0
3
1
0
5
4
0
0
5
0
0
0

7.98
100
0
9.3
0
0
28
8.33
8.46
100
0
0
3.77
15.48
18.18
17.99
4.43
12.87
7.38
21.31
0
15
2.5
0
5.81
3.13
0
0
5.81
0
0
0

Note: It is from author's search using the search engine Google.com in May 2003.
It is not statistical data, some notes are needed.

Appendix B: Reported and Estimated Prize by Districtin 2002, 2003, 2004
District
Dongcheng
Xicheng
CongwenXuanwuChaoyang
Fengtai
Shijingshan
HaidianMentougou
FangshanChangping
ShunyiTongzhouDaxingPingguHuairou
Miyun

Prize (by period) reported by media (homeapge,
newspaper)
2002/10/1-2002/12/31: 212500; 2003/4/112003/4/18: 62500
2002/10/1-2002/12/10: 100000; 2002/10/12003/1/31: 295000; 2003/1/1-2003/2/28:
193600; 2003/1/1-2003/12/31: 1237000
2002/10/1-2002/12/31: 88400; 2003/1/12003/12/31: 586800
2002/10/1-2003/12/31: 122650
2002/8/1-2002/8/29: 47000; 2003/1/12003/1/31: 157300; 2004/1/1-2004/6/10:
1929010
2003/1/1-2003/6/30: 332960; 2004/1/12004/12/31: 1780000
2003/1/1-2003/10/31: 320150; 2003/1/12003/12/31: 385950
2002/10/1-2002/12/31: 297800; 2003/1/12003/12/31: 2256300; 2005/1/1-2005/1/31:
1230000
2002/10/1-2002/12/31: 11700; 2003/1/12003/5/31: 55000
2002/8/1-2002/9/9: 8400; 2003/1/1-2003/9/30:
78860; 2002/8/1-2004/7/19: 238000
2002/10/8-2003/1/31: 89740; 2002/10/82003/10/30: 300190; 2002/10/8-2004/8/3:
1046870
2002/8/1-2002/12/26: 100900; 2002/8/12003/4/22: 170000; 2003/1/1-2003/7/14: 122430
2002/10/1-2002/11/6: 7700; 2002/10/12003/9/29: 162400
2002/10/1-2002/12/25: 33000; 2002/10/12003/11/21: 261950
2002/8/1-2002/10/22: 7000; 2002/10/12003/1/31: 34800; 2002/8/1-2003/11/14: 114700
2001/1/1-2001/12/31: 140000; 2002/8/12002/8/31: 8000; 2004/1/1-2004/7/22: 344270
2004/1/1-2004/5/31: 153000

Prize in Yuan in Prize in Yuan in
2002 (the italic is 2003 (the italic is
estimated value) estimated value)
2125008500001982001237000

88400

586800

24530

98120

455388245935986708

66592036548

3859502978002256300

11700

13200031795

13911365703

28385810437923034531792

16240035357

229285

26557

89265

40000

358133

19575

210058

2002/10/1-2003/1/16: 11000; 2005/1/19340
189394
2005/3/31: 93400
Reported total 2002/8/1-2002/12/31: 1669700; 2003/1/12003/12/31: 1117000; 2004/1/1-2004/12/31:
1669700
1117000
prize (all41769600
districts)
Estimated
1776273
10563301
total prize (alldistricts)
Note: The italic values are estimated by the author with the reported data in mass media.
YanqingAppendix C: Definition of Variables
Variable

Definition (method of making variable)

tax̲revenue

nominal total tax revenues by district, (10,000 Yuan)business̲tax

nominal business tax revenues by district, (10,000 Yuan)

gdp
second̲sector̲gdp
third̲sector̲gdp

nominal GDP by district, (10,000 Yuan)
nominal GDP of the second sector by district, (10,000 Yuan)
nominal GDP of the third sector by district, (10,000 Yuan)

population

population by district, (10,000 persons)

cpi
prize
real̲revenue
real̲business̲tax

consumer price index, (1998=100)
prize by district, (Yuan, per district)=tax̲revenue/population/cpi*100, (Yuan, per capita)=business̲tax/population/cpi*100, (Yuan, per capita)

real̲gdp=gdp/population/cpi*100, (Yuan, per capita)

real̲secondary̲gdp=second̲sector̲gdp/population/cpi*100, (Yuan, per capita)

real̲third̲gdp
real̲prize
experiment=third̲sector̲gdp/population/cpi*100, (Yuan, per capita)=prize/population/cpi*100, (Yuan, per capita)
dummy, 1 for the experiment district, 0 for the non-experiment district

after
LRE
ΔLRE
Δ Total tax revenue
Δ Business tax revenue

dummy, 1 for the experiment period, 0 for the non-experiment period=experiment*after=LRE(t)-LRE(t-1)=real̲revenue(t)-real̲revenue(t-1)=real̲business̲tax(t)-real̲business̲tax(t-1)

ΔGDP
ΔGDP of 2nd sector
ΔGDP of 3rd sector=real̲gdp(t)-real̲gdp(t-1)=real̲secondary̲gdp(t)-real̲secondary̲gdp(t-1)=real̲third̲gdp(t)-real̲third̲gdp(t-1)Δreal̲prize
log(Total tax revenue)log(Business tax revenue)log(GDP)log(GDP of 2nd sector)=real̲prize(t)-real̲prize(t-1)=log(real̲revenue)=log(real̲business̲tax)=log(real̲gdp)=log(real̲secondary̲gdp)

log(GDP of 3rd sector)
Δlog(Total tax revenue)
Δlog(Business tax revenue)
Δlog(GDP)
Δlog(GDP of 2nd sector)=log(real̲third̲gdp)=log(Total tax revenue)(t)-log(Total tax revenue)(t-1)=log(Business tax revenue)(t)-log(Business tax revenue)(t-1)=log(GDP)(t)-log(GDP)(t-1)=log(GDP of 2nd sector)(t)-log(GDP of 2nd sector)(t-1)Δlog(GDP of 3rd sector)=log(GDP of 3rd sector)(t)-log(GDP of 3rd sector)(t-1)

Note: t, t-1, means t period and t-1 period, respectively.