Enterprise income tax and corporate innovation: evidence from China

Abstract

ABSTRACT Using China’s 2008 enterprise income tax (EIT) reform, this study examines the effect of EIT on corporate innovation comprehensively. Based on accurate identification of the direction of changes in the corporate tax rate, we introduce two dummy variables of tax rate decline and escalation to investigate the impact of EIT changes simultaneously. Using the firm-level dataset from China’s A-share listed companies, we find that the innovation level of tax-rate-declining enterprises will increase by 0.2%, whereas the innovation level of tax-rate-increasing enterprises will decrease by 0.4%. The dynamic effect demonstrates that the aforementioned promoting and inhibitory effects are continuous. Heterogeneity analyses reveal that the changes in the EIT rates have a greater impact on the innovation level of enterprises with high innovation demand, manufacturing enterprises, enterprises in a high rule of law environment, and enterprises in the eastern region. Our study highlights the importance of the EIT reform on corporate innovation and guides how to better optimize the effectiveness of such policies.