Tax incentives and firm pollution

This paper investigates the causal effect of tax incentives on firms’ pollution behavior based on unique government administrative data of firm-level toxic emissions. Using the staggered value-added tax (VAT) reform in China as an exogenous shock to conduct a difference-in-differences estimation, we find that tax cuts have a considerable negative effect on firm pollution. The potential mechanisms of our findings are that the VAT reform (i) stimulates investment in fixed assets for environmental protection, and (ii) accelerates technological progress, both of which reduce firm pollution. Our results are robust to a battery of endogeneity tests and alternative specifications. We find that SOEs, large firms, firms with a high level of subsidies, firms located in stricter environmental-regulation areas and firms in water-polluting industries experience a greater decline in pollution after the VAT reform. Overall, this study provides a timely policy evaluation of the importance of tax incentives for environmental protection in developing countries like China.