Abstract
This study examines the effect of consumption tax adoption on firm innovation. Using a cross-country sample from 1990 to 2015, we find that firms decrease their innovation intensity but manage to maintain their innovation quality following the tax adoption. Further analyses reveal that firms primarily decrease low-quality innovation in response to the decrease in consumer demand following the tax adoption. They also exhibit higher originality and explore a broader set of new knowledge during innovation, which helps differentiate their products to compete for customers. However, we find that firms’ ability to transform innovation strategies depends on their pre-existing financial capability.
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