China Industrial Economics, 2023, Issue 2

Authors: LYU Yue, ZHANG Haotian, XUE Jinjun, ZHAO Xujie

Abstract: Green development is the key element of the new development philosophy. With domestic economic growth being weak, China's environmental regulation is facing a severe challenge. Therefore, how to enhance firms’ endogenous motivation to carry out emission abatement has become a key issue.The tax incentive is one of the most immportant institutional designs for the government's supply-side reform under the market economy system. In recent years, China has made public a number of tax incentive policies to stimulate firms’ investment vitality. Then, do tax incentives have the effect of enhancing firms’ endogenous motivation folemission abatement? Clarifying this issue helps to formulate effective tax incentive policies guide firms to reduce emissions, and thus promote China's green economic development. We study the effect of tax incentives on firms’ pollutant emissions based on China's value-addedtax(VAT) transformation reform in the period of 2004-2009. We first develop a novel heterogeneous firm model by introducing VAT incentives and fims’ pollutant emissions and decompose the effect of tax incentives on pollutant emissions of firms into the R&D effects, the clean manufacturing effects, and the scale production effects. The VAT transformation reform reduces firms’ pollutant emissions by increasing fims’ R&D investment and abatement investment, but it also increases firms’ pollutant emissions by expanding firms’ production scale. We then use the firm-level data of the Annual Survey of Industrial Firms and the China Environmental Statistics ftom 2000 to 2012, and apply the staggered difference-in-difference estimation to empirically examine the effect of tax incentives on pollutant emissions, regarding China's VAT transformation reform in the period of 2004-2009 as a quasi-natural experiment.We find that the VAT transformation reform significantly promotes firms to reduce pollutant emissions through increased R&D investment and abatement investment of firms. Surprisingly, the VAT transformation reform also causes firms to expand production scale, indicating that it does not reduce pollutant emissions at the cost of restricting firms’ capacity. In addition, the effects are greater for private firms, capital-intensive firms, and firms in eastern China. Finally, the VAT transformation reform not only promotes the emission abatement of incumbent firms. but also forces high-polluting firms to exit the market and promotes clean firms to enter, thus reducing the overall scale of emissions. Our study provides inspiration for designing an institutional mechanism to realize coordinated economic and ecological advancement.

Keywords: tax incentives; value-added tax(VAT) transformation; pollution governance; green tax system