Capital-biased tax incentives and labor market power: Evidence from China

Abstract

This paper identifies the causal effect of capital-biased tax incentives on labor market power by analyzing China’s 2004 value-added tax pilot reform, which enabled firms to deduct investment in production capital. We utilize firm-level administrative data to estimate production functions and compute wage markdowns. Our difference-in-differences analysis reveals that the reform increased labor market power by approximately 6.1%, largely through a labor-saving growth channel without a comparable increase in wages. The effect is more pronounced among firms that are already better positioned to take advantage of cheaper production capital.