Local government fiscal squeeze, environmental regulation and firms' polluting behavior: Evidence from China

Government fiscal capability is closely related to the environmental regulation policy, but few studies have considered the effect of local government fiscal squeeze on firms' environmental decisions. Adopting a sample of Chinese industrial firms between 2002 and 2012, we implement a difference-in-differences (DD) method to examine the influence of fiscal squeeze on firms' polluting behavior. We find that fiscal squeeze leads to more sulfur dioxide emissions from firms. This effect is only significant on large-scale firms, private firms, firms whose taxes are collected by the local taxation bureaus (LTB), and firms in heavily polluting sectors. We further investigate the potential mechanism and find that, resulting from the fiscal squeeze, local governments seek to expand their tax base by relaxing environmental regulations. The results suggest that keeping fiscal revenue stable is conducive to improving air quality.