How polluting enterprises respond to Pigovian tax: Evidence from China's environmental protection tax law

Abstract

China officially implemented an environmental protection tax in January 2018. This policy ranks among the most comprehensive environmental regulations worldwide, particularly due to its extensive coverage of enterprise pollution sources. However, the manner in which polluting enterprises respond to this environmental protection tax remains unclear. Using China's A-share listed enterprises in heavily polluting industries from 2008 to 2021 as our sample, we conduct an in-depth analysis of the adaptive behaviors of polluting enterprises to this reform. Our findings show that the reform significantly encourages polluting enterprises to reduce emissions, with the most pronounced effects observed in wastewater reduction. The mitigation effect intensifies initially but gradually diminishes over time. In addition, this study clarifies and structures the mechanisms through which reforms affect the emission reductions of enterprises by analyzing source prevention, process modification, and end-of-pipe treatment. The study indicates that businesses predominantly depend on green innovations—particularly green utility model innovations—to mitigate emissions in response to the environmental protection tax. Heterogeneity tests reveal that the pollution reduction effect of the reform is more pronounced among enterprises with higher expected benefits but less evident among those facing higher expected penalty costs. These findings help us understand the adaptive behaviors of polluting enterprises in developing countries under the Pigovian tax.