Do tax incentives decelerate corporate financialization? Evidence from the VAT reform in China

Abstract

Excessive corporate financialization, i.e., firms increasingly investing more in financial assets rather than productive assets, can harm firms' growth and the economy as a whole. The literature focuses on the causes of firms' cash-holding but neglects the effect of public policy on firms' non-cash financialization. With data on China's industrial firms (2000–2012), this study examines the effect of tax incentives on the corporate financialization of non-financial firms by using the value-added tax (VAT) reform in China as a natural experiment. We find that the VAT reform significantly reduces corporate financialization, and the finding is robust to different specifications. The mechanism analysis shows that the VAT reform increases the return rates on fixed assets, improving their attractiveness; and also decreases their demand for liquidity to hedge business risks. The implication is that tax incentives can serve as a policy instrument to decelerate excessive financialization, avoiding financial risks and economic slowdowns.