Decentralized government and firm pollution discharges: Evidence from China’s Province-Managing-County reform

Abstract

This paper investigates the environmental impact of a decentralization policy, China’s Province-Managing-County (PMC) reform, aimed at stimulating local economic growth by granting counties greater fiscal authority. Leveraging firm-level panel data on pollution emissions, we employ a difference-in-differences method to examine how the PMC affects pollution emissions, providing micro-level evidence to the literature on fiscal policies and environmental outcomes. Our results indicate that the PMC reform leads to increases in water pollution by 36.8% and air pollution by 8.6%. The mechanisms behind these findings are linked to local governments’ incentives to boost tax revenues and economic growth, which drive increased firm output, tax payment, and expanded production capacity. We identify heterogeneity across counties and firms: counties with higher pre-reform fiscal revenue experience less pollution growth, while firms affiliated with county governments show greater increases in emissions. These results highlight the trade-offs between fiscal decentralization and environmental protection, suggesting that policies aimed at economic growth should also incorporate measures to evaluate environmental damages.