Do R & D tax incentives work? Firm-level evidence from China

Tax incentives have been used worldwide to encourage firm R & D, but there is little evidence on their effectiveness as a policy tool in developing countries. We use a panel dataset of Chinese listed companies covering 2007 to 2013 to assess the effects of tax incentives on firm R & D expenditures and analyze how institutional conditions shape these effects. Our results show that tax incentives motivate R & D expenditures for our sample firms. A 10% reduction in R & D user costs leads firms to increase R & D expenditures by 3.97% in the short run. We also find considerable effect heterogeneity: Tax incentives significantly stimulate R & D in private firms but have little influence on state-owned enterprises' R & D expenditures. Moreover, the effects of tax incentives are more pronounced for private firms without political connections. Hence, reducing political intervention complements tax incentives' capacity to foster firm R & D in developing countries.