Innovation incentives and corporate tax avoidance: Evidence from China

Abstract

This paper examines the impact of an innovation incentive policy on corporate tax avoidance, utilizing China's R&D expenditure super deduction policy reform in 2016 as a natural experiment. Our findings reveal that the implementation of the super deduction policy significantly amplifies the book-tax gap of enterprises, indicative of an increased degree of tax avoidance. We also find that when enterprises are treated by innovation incentive policies, they will increase investment, and the magnitude of investment expenditure surpasses the preferential treatment enjoyed by enterprises, thereby impeding their cash flow. In circumstances where external financing is not easily alterable, tax avoidance becomes an internal financing option for enterprises. Further, we find that both widening policy coverage and enhancing policy benefits increase tax avoidance among firms, with enhancing benefits having a greater impact. In addition, this impact is more pronounced in firms with low cash holdings, small scale, non-state ownership, or high financial constraints.