Notching R&D Investment with Corporate Income Tax Cuts in China

Zhao Chen, Zhikuo Liu, Juan Carlos Suárez Serrato, Daniel Yi Xu

NBER Working Paper No. 24749
Issued in June 2018, Revised in March 2019
NBER Program(s):Development Economics, Industrial Organization, Public Economics, Productivity, Innovation, and Entrepreneurship

We analyze the effects of a Chinese policy that awards substantial corporate tax cuts to firms that increase R&D investment over a given threshold, or notch. We exploit this quasi-experimental variation with administrative tax data in order to shed light on longstanding questions on the effects of fiscal incentives for R&D. We find large responses of reported R&D using a cross-sectional “bunching” estimator that is new to the R&D literature. We also find significant increases in firm-level productivity, even though about 30% of the increase in R&D is due to relabeling of administrative expenses. Anchored by these reduced-form effects, we estimate a structural model of R&D investment and relabeling that recovers a 9.8% return to R&D. We simulate alternative policies and show that firm selection into the program and the relabeling of R&D determine the cost-effectiveness of the policy, and the effects on productivity growth.

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Document Object Identifier (DOI): 10.3386/w24749