The Effect of Investment Tax Incentives: Evidence from China’s Value-Added Tax Reform

Abstract

We estimate the impact of investment tax credit on firm fixed investment, using China’s 2004 value-added tax reform pilot that introduces a permanent 17%-tax credit for fixed investment in six industries in the Northeastern region. The tax credit raises significantly fixed investment of eligible firms by 28 percent on average during 2004-2007 relative to 2001-2003, corresponding to a user cost elasticity of 1.84. The result is largely driven by responses of domestic private firms and is robust to specifications addressing the issue of anticipation. Smaller firms and firms with larger cash flow respond more strongly to the tax credit.