Tax incentive and firm investment: Evidence from the Income Tax Revenue Sharing Reform in China

Abstract

Abstract How to stimulate enterprise investment is a dilemma facing most countries, and tax incentives are frequently used as a solution. This study explores how China's Income Tax Revenue Sharing Reform affected enterprises' fixed asset investment (FAI). This reform did not modify the nominal tax rate or depreciation allowance directly but changed the effective enterprise income tax (EIT) rate via switching tax administration indirectly. And the change in the effective EIT rate should affect firm investment. This paper uses a regression discontinuity (RD) design to conduct a quasi‐natural experiment of the reform in 2002 based on an enterprise‐level dataset from the Annual Survey of Industrial Enterprises (ASIE). After the reform, the effective EIT rate (ETR) of enterprises collected by the State Administration of Taxation (SAT) was 11% lower than that collected by the Local Administration of Taxation (LAT). FAI improves by 0.7% for every 1% decrease in ETR. Tax avoidance is a key channel for the ETR to affect FAI. The FAI of smaller companies, non‐state‐owned enterprises (SOEs) and companies with high size‐age (SA) indexes has responded more significantly to the change in ETR brought about by reform.