How does the environmental protection tax law affect firm ESG? Evidence from the Chinese stock markets

The serious environmental pollution problem has been proven to harm people's health and economic development in China. Chinese authorities implemented the Environmental Protection Tax Law (EPTL) in 2018-the first environmental tax law in this country-to solve the problem. Since firms are main objects of this policy, its effect on firms' sustainable development capacity is a worthwhile but not yet discussed question. Therefore, this study adopts the Environmental, Social, and Governance (ESG) to quantify firms' sustainable development capacity and employs the difference-in-differences method to investigate the above research question using a sample of A shares listed in Chinese stock markets from 2014 to 2021. Benchmark regression and robustness tests demonstrated that the EPTL could promote heavily polluting firms' ESG, thus, confirming the Porter hypothesis' existence in China from a micro perspective. We conducted a series of additional tests to provide insight into the effects of the EPTL under different circumstances, and achieved the following important findings: a) although a time-lag effect exists, the policy effect increases over time; b) the boosting effect of this policy is stronger on higher ESG firms than on lower ESG firms; c) innovation compensation effect and government financial subsidies can exponentially increase the EPTL's effect on firm ESG; and d) this policy has an inhibiting effect on politically connected firm's ESG. Based on these findings, we provide theoretical and practical suggestions for academia and policymakers. The Chinese authorities should insist on enforcing the EPTL in the long run, encourage firms on research and development investments, and provide them more financial subsidies, so as to enhance the policy's effect. Moreover, the government should implement some supporting policies to improve the sustainable development capacity of politically connected firms.