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 November 2019
NBER Program(s):Development Economics, Industrial Organization, Public Economics, Productivity, Innovation, and Entrepreneurship

We study a Chinese policy that awards substantial tax cuts to firms with R&D investment over a threshold, or notch. Quasi-experimental variation and administrative tax data show that firms significantly increase reported R&D, and that relabeling of expenses accounts for 30% of this increase. Accounting for relabeling is crucial to obtain unbiased estimates of the productivity effects of real R&D and to quantify the fiscal costs of stimulating R&D. We estimate a 9.8% productivity-to-R&D elasticity using a structural model of investment and relabeling. Policy simulations show that selection into the program and relabeling costs determine the cost-effectiveness of stimulating R&D.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w24749