Journal of Applied Economics

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The unintended consequences of environmental

tax for green innovation: evidence from China

Haohan Luo & Ying Wu

To cite this article: Haohan Luo & Ying Wu (2023) The unintended consequences of
environmental tax for green innovation: evidence from China, Journal of Applied Economics,
26:1, 2286566, DOI: 10.1080/15140326.2023.2286566

To link to this article: https://doi.org/10.1080/15140326.2023.2286566

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JOURNAL OF APPLIED ECONOMICS
2023, VOL. 26, NO. 1, 2286566
https://doi.org/10.1080/15140326.2023.2286566

RESEARCH ARTICLE

The unintended consequences of environmental tax for green

innovation: evidence from China
Haohan Luoa and Ying Wub
a
Business School, Chengdu University of Technology, Chengdu, Sichuan Province, China; bSchool of
Business, Nanjing Normal University, Nanjing, Jiangsu Province, China

ABSTRACT ARTICLE HISTORY

Can all types of tax burdens negatively affect corporate innovation Received 24 July 2023
activities? The Chinese Environmental Protection Tax Law provides Accepted 16 November 2023
a chance to investigate the impact of environmental taxes on KEYWORDS
corporate green innovation. Using a large sample of Chinese listed Environmental tax; Chinese
firms for the 2015–2019 period and the difference-in-difference Environmental Protection
method, this paper finds that environmental taxes promote corpo­ Tax Law; green innovation;
rate green innovation. This result is robust to a battery of sensitivity China
tests and is more prominent for firms facing intense product market
competition, firms with more financial constraints, and firms
located in lower marketization regions. Mechanism tests find that
firms engage in green innovation to cater to government environ­
mental governance. Additional analyses find that environmental
taxes have a significant effect on green innovation efficiency and
green utility model innovation but fail to impact green invention
innovations. Our study provides new and different evidence of the
impact of taxes on corporate innovation and has important policy
implications.

1. Introduction
Environmental issues make sustainable development and a circular economy more attractive
(Khurshid & Deng, 2021; Khurshid et al., 2022, 2023). Green innovations are regarded as an
essential way to address environmental exchange and achieve sustainable development
(Greco et al., 2022; Khurshid et al., 2023; Stojcic, 2021; Wang et al., 2023). Market failures,
however, may result from underinvestment in innovation activities, such as unpriced knowl­
edge spillover and financing constraints for innovation (Hall & Lerner, 2010; Nelson, 1959).
In addition to market failures, firms also have less incentive to develop green innovation
because using green technology in production can increase cost, given the higher price of
many renewable energy resources and technologies (Roe et al., 2001). Although firms can
improve product prices to balance the increase in product costs, whether consumers are
willing to pay a premium price for green products is doubtful (Michaud & Llerena, 2010), and
consumers simply consider that either the government or the firm should bear the costs and

CONTACT Ying Wu [email protected] School of Business, Nanjing Normal University, No. 1, Wenyuan Road,
Xianlin University City, Nanjing, Jiangsu Province 210023, China
© 2023 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group.
This is an Open Access article distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/
licenses/by/4.0/), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly
cited. The terms on which this article has been published allow the posting of the Accepted Manuscript in a repository by the author(s) or
with their consent.
2 H. LUO AND Y. WU

burden of social responsibility (Jiang & Kim, 2020). To promote corporate green innovation,
government policies play a significant role (Atanassov & Liu, 2020; Chen et al., 2021; Crespi
et al., 2016; Hu et al., 2021; Ivus et al., 2021; Stucki et al., 2018).
Taxes are one of the important ways for governments to intervene in corporate innovation
activities (Hall, 2021). Many studies suggest that tax reduction can stimulate innovation input
and innovation outputs (Chen & Yang, 2019; Crespi et al., 2016; Czarnitzki et al., 2011;
Howell, 2016; Ivus et al., 2021; Wang & Kesan, 2022); in contrast, increasing taxes impedes
corporate innovation (Atanassov & Liu, 2020; Li et al., 2021). However, Karydas and Zhang
(2019) develop a model and propose a different view that increasing environmental taxes may
promote technological innovation. Therefore, The Chinese Environmental Protection Tax
Law, enacted in 2018, provides an excellent opportunity to examine the impact of environ­
mental taxes on corporate innovation. In this paper, we investigate the impact of the Chinese
Environmental Protection Tax Law on corporate green innovation.
Following Amore and Bennedsen (2016), Yu et al. (2021), and Hu et al. (2021), we use
the number of green patents plus one to measure corporate green innovation. We adopt
the difference-in-difference (DID) method to identify the causal relationship between
environmental taxes and corporate green innovation because the Chinese Environmental
Protection Tax Law can be regarded as a quasi-natural experiment. Following Tu et al.
(2020), we divide a firm into the treated group when the firm belongs to the industry that
is defined as heavily polluting by the Guidelines for the Disclosure of Environmental
Information for Listed Companies issued by the Ministry of Environmental Protection of
China in 2010. Using a large dataset of all Chinese listed firms for the 2015–2019 period,
we document extensive evidence that environmental taxes are positively related to
corporate green innovation. This evidence is robust to changing the measure of green
innovation, excluding samples with zero patents, controlling the effect of air quality, and
testing the parallel trend assumption of the DID method.
The association between environmental taxes and corporate green innovation sup­
ports the view that firms cater to government environmental determination to obtain
more resources and opportunities. To identify the economic mechanism, we investigate
whether the relationship between environmental tax and corporate green innovation has
heterogeneity in different ownership structures. In China, firms can be divided into two
ownership types, namely, state-owned enterprises (SOEs) and non-SOEs. SOEs are
controlled by the government and are one of the important ways for the government
to intervene in the economy. Compared to non-SOEs, SOEs have a natural close relation­
ship with the government due to ownership and can easily access more resources, such as
larger shares of bank credits (Hu et al., 2021; Lin et al., 2020). Therefore, non-SOEs have
more incentive to cater to government environmental intention than SOEs. Our results
show that the relationship between environmental taxes and corporate green innovation
remains statistically significant in the non-SOE subsample, indicating that firms engage
in green innovation to cater to government environmental governance.
We also conduct a set of cross-sectional heterogeneity discussions. First, fierce
product competition makes firms strongly demand government help to obtain
advanced advantages, and we should observe that the impact of environmental
taxes on green innovation is more prominent in industries with fierce product
competition. Second, firms facing more financing constraints need more bank credit
to operate. Meanwhile, the bank sector in China is controlled by the government,
 JOURNAL OF APPLIED ECONOMICS 3

meaning that firms facing more financing constraints should conduct more green
innovation. Finally, the marketization process in different regions is uneven across
China. Higher marketization makes firms less dependent on the government and have
less incentive to engage in green innovation. Our results show that the association
between environmental taxes and corporate green innovation is more prominent for
firms with fierce product competition, firms with more finance constraints, and firms
located in regions with lower marketization.
According to Chinese patent law, patents are divided into three types, namely,
invention patents, utility model patents, and design patents. Invention patents have the
highest innovation content, as they cover novel technologies. Utility model patents have
fewer novel technologies and cover the new application of existing technologies. Design
patents cover product shapes and have very limited technological advancement. Scholars
pay attention to invention patents and utility patents when they investigate innovation
activities in China (Fang et al., 2017; Tan et al., 2020). We further study the impact of
environmental taxes on different innovation types. We find that environmental taxes
have a positive effect on green utility patents and fail to affect green invention patents.
Finally, we also find that environmental taxes promote green innovation efficiency.
This article contributes to the literature in several ways. (1) The paper provides new
and different evidence of the impact of tax policies on innovation activities. The prior
literature provides extensive evidence that tax reduction can promote corporate innova­
tion. This evidence remains valid for different capital markets, including developed
countries (Atanassov & Liu, 2020; Czarnitzki et al., 2011; Li et al., 2021) and developing
countries (Crespi et al., 2016; Howell, 2016; Ivus et al., 2021; Shao & Xiao, 2019), and
different tax policies, such as R&D tax credits (Czarnitzki et al., 2011; Ivus et al., 2021),
corporate income taxes (Atanassov & Liu, 2020; Shao & Xiao, 2019), and value-added
taxes (Howell, 2016). However, using the Chinese Environmental Protection Tax Law as
a quasi-natural experiment, we find that increasing taxes promotes corporate green
innovation. The new and different evidence in this paper suggests that different tax
policies targeting specific economic or social issues have different effects on corporate
innovation activities, and the institutional backgrounds in which firms operate also play
an important role in the impact of tax policies.

(2) The paper adds academic evidence on the economic effect of the Chinese
Environmental Protection Tax Law. Some papers have examined the impact of tax
policies, such as firm performance (He et al., 2020, Tu et al., 2020) and air pollution
(Han & Li, 2020). This paper examines the impact of the new law on corporate green
innovation, which deepens our understanding of the impact of the environmental tax
policy.
(3)) This paper enriches the literature on the role of environmental taxes in environmental
protection. Previous studies provide tremendous evidence that environmental taxes
help to reduce carbon emissions and achieve a green economy (Shahzad, 2020;
Khurshid & Deng, 2021; Khurshid et al., 2022; Khurshid et al., 2022; Wang et al.,
2022; Li et al., 2023; Khurshid et al., 2023b, 2023a). Given that green innovation can
alleviate carbon emissions (Wang et al., 2022), the findings of this paper provide
mechanistic explanations for the role of environmental taxes in promoting green
development.
4 H. LUO AND Y. WU

The rest of this paper is organized as follows. We provide the background of the Chinese
Environmental Protection Tax Law in Section 2, review the related literature and develop
hypotheses in Section 3, discuss our sample, variables, and model in Section 4, and report
the empirical results in Section 5. In Section 6, we conclude the paper and provide policy
implications and further research.

2. Background of the Chinese Environmental Protection Tax Law

After the economic reform in the late 1970s, China experienced rapid growth and created
an economic miracle. Due to the previous rude economic model, environmental issues
accompanied economic development. The government started charging a fee for pollu­
tion in 1982, which was called the pollutant discharge policy. However, economic
development was the top priority (Zhang et al., 2016). The policy had relatively low
fees for pollution charges and did not distinguish between different pollutants (He et al.,
2020). In 2003, China formalized a pollution charge policy, namely, the Regulations on
Collection and Use of Pollution Discharge Fee, which distinguished different pollutants
and increased fees for the charge. However, the policy received less success because of the
lack of a legal basis for the environmental and primary goals of the economic develop­
ment of local governments. Environmental issues are becoming increasingly serious with
economic development. According to The Global Burden of Diseases 2010, air pollution
annually causes approximately 1.2 million premature and 25 million disability-adjusted
life-years in China.
Environmental issues have received increasing attention from the Chinese. People
have asked the government to tackle environmental issues. After the Eighteenth National
Congress of the Communist Party of China in 2012, President Xi was elected president.
China’s environmental governance reached a new milestone. President Xi repeatedly
strengthened the importance of environmental protection and declared that green
mountains and green waters are gold and silver. China began to develop a more perfect
legal system. In 2014, The Ministry of Environmental Protection, together with the
Ministry of Finance and the State Administration, declared that they had drafted The
Chinese Environmental Protection Tax Law. In 2015, the Legislative Affairs Office of the
State Council issued the draft and sought the opinions of all stakeholders of the society.
The Chinese Environmental Protection Tax Law was passed at the 25th meeting of the
Standing Committee of the 12th National People’s Congress in 2016 and came into effect
on 1 January 2018. The law defines the legal status of the pollutant discharge fee from
administrative fees to taxes.
The law consists of five chapters and 28 articles. Article 1 of the law declares that the
law is formulated for the purpose of protecting and improving the environment, redu­
cing the emission of pollutants and promoting the construction of ecological civilization.
Article 3 of the law mandates that air pollutants, water pollutants, solid waste, and noise
are the items taxed. More importantly, article 6 of the law gives detailed information on
tax items and the price of the environmental protection tax. In Chapter 4, the law
provides detailed and strict regulations for the implementation of environmental taxes.
For example, article 23 of the law points out that taxpayers or tax authorities are
responsible for taxing. In summary, the law provides a legal safeguard for environmental
governance and has significance (He et al., 2020).
 JOURNAL OF APPLIED ECONOMICS 5

Against the background that many countries are implementing the 2030 Agenda for
Sustainable Development, China’s government enacted the Environmental Protection
Tax Law in 2018 to achieve sustainable development and reduce the adverse impact of
human economic activities on the environment. Green innovation is the most important
technological way to reduce environmental issues. Therefore, it is important to estimate
whether the environmental tax law affect corporate green innovation in a timely manner.

3. Literature review and hypothesis development

3.1. Literature review
Taxes are one of the important policy tools that affect corporate innovation. The literature
focuses on the relation between tax policy and corporate innovation (Hall, 2021). In
general, the tax policies affecting innovations can be divided into two types, namely,
research and development (R&D) tax credits and other tax policies. R&D tax credits
involve tax grants for R&D expenditure and directly impact innovation input. Many
scholars find that R&D tax incentives have a positive effect on corporate innovation
(Castellacci & Lie, 2015; Czarnitzki et al., 2011; Ivus et al., 2021; Tian et al., 2020) and
that firm characteristics, such as firm size (Chen & Yang, 2019) and life cycle (Chiang et al.,
2012), affect the positive association between R&D tax incentives and corporate innova­
tion. Other tax policies, such as corporate income tax and value-added tax, affect innova­
tion activities by changing mainly corporate financial constraints. The extant literature
suggests that tax reduction can stimulate innovation input and innovation outputs
(Atanassov & Liu, 2020; Crespi et al., 2016; Howell, 2016; Shao & Xiao, 2019; Wang &
Kesan, 2022; Zheng & Zhang, 2021). In contrast, increasing taxes has a negative effect on
corporate innovation activities. For example, Atanassov and Liu (2020) document that
corporate income tax cuts can promote innovation; in contrast, increasing taxes has
a negative effect on innovation. Li et al. (2021) find that a tax avoidance crackdown leads
to a significant decrease in innovation outputs. In summary, prior studies seem to provide
a solid concept that tax reduction policies are conducive to innovation activities. However,
Karydas and Zhang (2019) develop an endogenous growth model and point out that
environmental taxes may promote economic growth by inducing corporate innovation
under conditions:(1) labors can move between R&D sector and manufacturing; (2) the
elasticity of substitution in manufacturing between energy and scarce factors should be
lower than unity. Furthermore, using survey data, Stojcic (2021) finds that environmental
taxes promote green innovation. The prior literature fails to reach an agreement on the
impact of tax policies on corporate innovation activities.
Environmental tax has been regarded as an important tool to address environmental
problems (Khurshid & Deng, 2021; Khurshid et al., 2022, 2023; Li et al., 2023; Shahzad, 2020).
The Chinese government implemented the Environment Protection Tax Law in 2018, which
was the first environmental tax policy. Some papers have examined the impact of tax policies.
For example, using the event study method, He et al. (2020) document that the new law
increases environmental costs and has a negative effect on firm performance. Han and Li
(2020) use a Bayesian space-time model to test the impact of the new law on air pollution at
6 H. LUO AND Y. WU

the provincial level in 2018 and find that the new law helps to improve air quality. Tu et al.
(2020) find that a significant negative reaction is related to the new law. However, we know
little about how the law affects corporate innovation.
Through a literature review, we find that there are two research gaps. First, the
findings on the relationship between tax policy and corporate innovation are mixed.
To ensure the impact of tax policy on corporate innovation activities, we need to provide
more evidence. In addition, we fail to know how the Chinese Environmental Protection
Tax Law affects corporate green innovation. Therefore, this paper examines the impact of
the Chinese Environmental Protection Tax Law on corporate green innovation.

3.2. Hypothesis development

There are two opposing theoretical views about the association between environmental
taxes and corporate green innovation. The first view argues that environmental taxes
have a negative impact on corporate green innovation. Unlike routine investment tasks
that follow conventional technology and generate quick returns, innovation is a long-
term and risky process that produces intangible assets (Holmstrom, 1989). In addition,
the inventor has better information about the likelihood of the nature and the likelihood
of success of the contemplated innovation projects than outside potential investors (Hall
& Lerner, 2010). These characteristics of innovation activities make it difficult for firms
to finance innovation, and financial constraints are a key obstacle to innovation
(Gorodnichenko & Schnitzer, 2013). It is inevitable for firms to cause environmental
issues in operation. Compared to that of developed countries, China’s economy is
unsustainable, with high energy consumption, high production input, high pollution
emissions, and low economic efficiency (Li & Du, 2021), suggesting that firm operation
may have a greater adverse effect on the environment. After the enactment of the Chinese
Environmental Protection Tax Law, firms need to pay taxes for their environmental
issues. This means that environmental taxes will increase corporate burden and
strengthen financial constraints, which dampen corporate green innovation (Atanassov
& Liu, 2020; Howell, 2016; Hu et al., 2021; Wang & Kesan, 2022).
However, according to the Porter hypothesis (Porter & van der Linde, 1995),
a stringent environment regulation may offset regulation costs and promote innovation
outputs. Against the specific background of China, environmental regulations may have
a larger effect on corporate innovation behaviors and lead to innovation benefits over
regulation costs. Environmental taxes may have a positive effect on corporate green
innovation. Although China moved from a central planned economy to a market-
oriented social economic system in the late 1970s, the government still has a significant
impact on firm operations (Jiang & Kim, 2020). For example, the China Securities
Regulatory Commission, which is a government department and the main securities
regulator in China, has hindered or restricted firms’ ability to initiate public offerings and
conduct seasoned equity offerings. The bank sector, the dominant source of corporate
financing in China, is controlled by state-owned banks (Chong et al., 2013; Jiang & Kim,
2020). In addition to satisfying consumer requirements (Safaei et al., 2022), having a close
relationship with the government helps firms obtain more resources and opportunities
than firms without connections (Kim et al., 2018). One of the most important ways to
build a close relationship with the government is to cater to government policies. In
 JOURNAL OF APPLIED ECONOMICS 7

recent years, the Chinese government has realized that unsustainable economic growth
has been detrimental to the environment, and China needs to transition from unsustain­
able development to sustainable development. President Xi has strengthened the impor­
tance of environmental protection and achieved sustainable development on many
occasions and pointed out that green mountains and green waters are gold and silver.
In addition, the government issued many policies to achieve sustainable development,
such as the Green Credit Guides in 2012, the Air Pollution Prevention and Control
Action Plan in 2013, the New Environmental Protection Law in 2015, and the Chinese
Environmental Protection Tax Law in 2018. These policies clearly convey the commit­
ment that the Chinese government wants to achieve sustainable development. In this
context, although the Chinese Environmental Protection Tax Law charges taxes for firms’
environmental issues, firms may have a stronger incentive to engage in green innovation
to cater to government governance policy.
Based on the above analysis, we propose the following hypothesis.

Hypothesis 1: The environmental protection tax reduces corporate innovation outputs.

Hypothesis 2: The environmental protection tax promotes corporate innovation outputs.

4. Sample, variables, and empirical method

4.1. Sample
To construct our sample, we start with all Chinese A share listed companies during the
2015–2019 period. Please note that the sample period is from 2016 to 2019 for green
innovation and from 2015 to 2019 for the control variables. The firm financial data are
collected from the China Securities Market and Accounting Research (CSMAR) data­
base. The green patent data are collected from the Chinese Research Data Service
(CNRDS) database.1 Then, we exclude financial service firms and firm-year observations
with missing information for the control variables. Our final sample includes 10,526
firm-year observations representing 3137 firms. To mitigate the effect of outliers, we also
winsorze all continuous variables at the 1% and 99% levels.

4.2. Measuring corporate green innovation

Patents are the most common indicator used to measure innovation (Amore &
Bennedsen, 2016; Atanassov & Liu, 2020; Fang et al., 2017; Hu et al., 2021; Kong
et al., 2020), as patenting is an important means by which firms can protect their
technological inventions (Chang et al., 2019). Following Hu et al. (2021), we use the
number of green patents that were applied for during each firm year. According to
the patent application file, the Chinese State Intellectual Property Office (CSIPO)
determines the type of a patent, namely, invention patent, utility model patent, or
1
We use the data of green patents provided by the CNRDS database in 2020 because the database changes the statistic
caliber in the latest data.
8 H. LUO AND Y. WU

design patent. Scholars usually only include invention patents and utility model
patents when investigating innovation activities in China, as these patents represent
significant technological improvements (Fang et al., 2017; Kong et al., 2020; Tan
et al., 2020). In this paper, we only include green invention patents and green utility
model patents when we count the number of firm green patents. In addition, the
patent application year is closer to the time of actual innovation than the grant year
(Tian & Wang, 2014). Finally, due to the right skewness of the number of green
patents, following Chang et al. (2019) and Kong et al. (2020), we adopt the natural
logarithm of one plus the number of green invention patent applications and green
utility model patent applications to measure corporate green innovation (Patent).2

4.3. Empirical model

To examine whether the Chinese Environmental Protection Tax affects corporate green
innovation, we use a generalized difference-in-difference method. Specifically, we inves­
tigate the difference in green innovation output in firms that are more affected before and
after the environmental tax law (“Treatment” group) compared to the same difference for
firms that are less affected (“control” group).3 Therefore, to use the method, we need to
divide firms into two groups, namely, the treatment group and the control group.
Following Tu et al. (2020), we define a firm as the treatment group when the firm
belongs to heavily polluting industries. Although government environmental regulations
affect all firms, firms in heavily polluting industries face more stress from government
regulations. The Ministry of Environmental Protection of China issued the Guidelines
for the Disclosure of Environmental Information for Listed Companies in 2010 that
defined which industries are heavily polluting.4 We used the guide to identify the
treatment group. In addition, following Chang et al. (2019), we lag one period for all
control variables because innovation needs time to develop. The following equation
describes the main regression model:
Patenti;t ¼ β0 þ β1 Treati � Postt þ γ0 Controli;t 1 þ μi þ υt þ εi;t (1)
where i denotes the individual firm and t denotes the year. Treat is an indicator
variable that equals 1 when a firm belongs to the treatment group and 0 other­
wise. Post is also an indicator that assumes a value of 1 to denote the post-
2018 period and 0 to denote the pre-2018 period. The control variables (Controls)
are the potential factors that have been shown in the literature to predict corpo­
rate innovation (Chang et al., 2019; Chen et al., 2021; Kong et al., 2020; Tan et al.,
2020; Wu & Dong, 2021). We include R&D expenses scaled by total assets to
control innovation input (R&D). We use the natural logarithm of the book value
of assets to control the effect of firm size (Size) and use net tangi assets divided
by total assets to account for capital intensity (Tangi). We capture the natural
logarithm of firm age to control the impact of a firm’s life cycle (Age). Return on
2
We design the observations without patent information as zero.
3
This method is widely used to estimate the effect of policy shocks (see Kong et al., 2020; Su et al., 2022; Xu et al., 2021).
4
Specifically, according to the Guideline for the Industry Classification of Listed Companies issued by the China Securities
Regulatory Commission in 2012, listed firms with the following industry codes are defined as the treatment group (B06,
B07, B08, B09, B10, B11, C14, C15, C16, C17, C18, C19, C22, C25, C26, C27, C28, C29, C30, C31, C32, and C33).
 JOURNAL OF APPLIED ECONOMICS 9

Table 1. Variable definitions.

Variables Definition
Patent The logarithm value of one plus the total number of green invention patent applications and green utility
patent applications.
Treat An indicator variable that equals 1 when a firm belongs to the treatment group and 0 otherwise.
Post An indicator that assumes a value of 1 to denote the post-2018 period and 0 to denote the pre-
2018 period.
RD R&D expenditure scaled by total assets.
Size The natural logarithm of total assets.
Lev Total debt divided by total assets.
Tangi The natural logarithm of the net tangible asset divided by total assets.
Cash Operating cash flow divided by total assets.
ROA Net profit divided by total assets.
Indep The number of independent directors divided by the number of directors.
Age The natural logarithm of firm age.
Duality A dummy variable that equals 1 when CEO is the same as chairperson, and 0 otherwise.

assets (ROA) is used to capture operating profitability. We use total debt divided
by total assets (Lev) and operating cash scaled by total assets (Cash) to control the
effect of capital structure. In addition, we control for the effect of corporate
governance on innovation. Specifically, we use the ratio of independent directors
(Indep) and CEO duality (Duality). Finally, we also include firm fixed effects (μi)
to control unobservable time-invariant firm-specific characteristics and year fixed
effects (υt) to control time trends.5 All variables are defined in Table 1.

5. Empirical results
5.1. Descriptive statistics
Table 2 reports the summary statistics on the variables used in our analysis. As shown in
Table 2, the mean value and median value of patents are 1.0118 and 0.6931, respectively,
indicating that there are large differences in green innovation outputs among firms. The

Table 2. Descriptive statistics.

Variable N Mean Std Min Median Max
Patent 10526 1.0118 1.2367 0.0000 0.6931 4.9488
Treat 10526 0.3430 0.4747 0.0000 0.0000 1.0000
Post 10526 0.5558 0.4969 0.0000 1.0000 1.0000
RD 10526 0.0217 0.0185 0.0001 0.0185 0.0998
Size 10526 22.1425 1.2513 19.9692 21.9861 26.0591
Lev 10526 0.4031 0.1998 0.0596 0.3872 0.9132
Cash 10526 0.0439 0.0659 −0.1490 0.0430 0.2283
ROA 10526 0.0377 0.0653 −0.2980 0.0389 0.1873
Tangi 10526 0.2023 0.1460 0.0033 0.1719 0.6577
Age 10526 1.9583 0.9383 0.0000 2.0794 3.2581
Indep 10526 0.3765 0.0536 0.3333 0.3636 0.5714
Duality 10526 0.3086 0.4619 0.0000 0.0000 1.0000
The table presents descriptive statistics for the corporate green innovation measure, treatment group measure, and
control variables.

5
We do not include the variables, Treat and Post, because we control these variables that are absorbed by the firm and
tear fixed effects (Kong et al., 2020; Su et al., 2022; Xu et al., 2021)
10 H. LUO AND Y. WU

findings are similar to those of Hao and He (2022). The mean value of Treat is 0.3430,
suggesting that approximately 34% of the observations belong to the treatment group. In
addition, the mean value of RD is 0.0217, which is close to the finding of Kong et al.
(2020). Finally, we find that CEO duality accounts for 30.86%.

5.2. Main regression

Table 3 represents the result of Equation (1). In Column 1, we only regress Patent
on Treat×Post, and the coefficient of Treat×Post is positive and significant at the
1% statistical level, indicating that environmental taxes promote corporate green
innovation. In Column 2, we control R&D investment (RD), firm size (Size),
capital structure (Lev and Cash), and return on assets (ROA), and the coefficient
of Treat×Post is positively significant. In Column 3, we add all control variables,
and the coefficient of Treat×Post is positive and significant at the 5% statistical
level, suggesting that environmental taxes have a positive effect on corporate
green innovation. This finding supports Hypothesis 2 and is consistent with the
theoretical view of Karydas and Zhang (2019) that a higher environmental tax
may stimulate corporate technological innovation. This means that the effect of
environmental taxes on innovation is different from that of other tax policies.

Table 3. Main results.

(1) (2) (3)
Patent Patent Patent
Treat×Post 0.0786*** 0.0686** 0.0686**
(0.0284) (0.0282) (0.0281)
RD 2.8384** 2.7220**
(1.2759) (1.2741)
Size 0.0922*** 0.0623*
(0.0342) (0.0355)
Lev −0.0424 −0.0855
(0.1077) (0.1090)
Cash −0.162 −0.147
(0.1500) (0.1511)
ROA 0.6518*** 0.6492***
(0.1785) (0.1795)
Tangi −0.214
(0.1610)
Age 0.1817***
(0.0377)
Indep 0.148
(0.2720)
Duality 0.0354
(0.0315)
Constant 0.9748*** −1.107 −0.764
(0.0126) (0.7475) (0.7888)
Firm fixed effects Yes Yes Yes
Year fixed effects Yes Yes Yes
N 10526 10526 10526
R2 0.0990 0.104 0.107
The table reports the results of the impact of environmental taxes on corporate
green innovation. The standard errors clustered at the firm level are reported in
parentheses. The symbols *, **, and *** denote significance at the 10%, 5%, and
1% levels, respectively.
 JOURNAL OF APPLIED ECONOMICS 11

In terms of control variables, we find that more R&D investment can promote corporate
green innovation, and larger firms have more green patents, which is consistent with the
findings of Chang et al. (2019). In addition, the coefficient of ROA is significantly positive,
indicating that firms with better profitability usually have more green innovation. Finally, we
fail to find that independent directors have a significant effect on green innovation, which is
consistent with the fact that firms usually employ independent directors to meet regulatory
requirements and that independent directors do not play a vital role in corporate governance
(Jiang & Kim, 2015).

5.3. Sensitivity tests

In this subsection, we run several sensitivity tests. First, to better measure innovation
outputs, scholars also use patent citations to measure scientific value or patent quality
(Chang et al., 2019; Tan et al., 2020). Therefore, we replace the measure of corporate
green innovation in Column 1 of Table 4. Specifically, we use the natural logarithm of the
total number of green invention patent citations and green utility model citations to
measure corporate green innovation (Patent1). As shown in Column 1 of Panel A in

Table 4. Sensitivity tests.

(1) (2) (3) (4)
Cite Patent Patent Patent
Treat×Post 0.2559*** 0.0915** 0.0675**
(0.0278) (0.0415) (0.0282)
RD −0.522 3.7707** 2.5941** 2.7838**
(1.2444) (1.6977) (1.2743) (1.2759)
Size −0.1279*** 0.1274** 0.0659* 0.0597*
(0.0369) (0.0517) (0.0358) (0.0357)
Lev 0.112 −0.3023* −0.0823 −0.0819
(0.1043) (0.1785) (0.1091) (0.1091)
Cash 0.0372 −0.0360 −0.136 −0.148
(0.1355) (0.2209) (0.1523) (0.1510)
ROA 0.149 0.7665*** 0.6540*** 0.6285***
(0.1396) (0.2676) (0.1817) (0.1797)
Tangi −0.4581*** −0.0476 −0.202 −0.214
(0.1514) (0.2820) (0.1628) (0.1608)
Age 0.2945*** 0.1114* 0.1838*** 0.1834***
(0.0350) (0.0632) (0.0377) (0.0376)
Indep −0.0487 −0.0518 0.177 0.162
(0.2683) (0.3859) (0.2739) (0.2722)
Duality 0.0471 0.0239 0.0372 0.0365
(0.0288) (0.0450) (0.0315) (0.0316)
AQI 0.2997**
(0.1292)
Treat×Year2016 0.0103
(0.0386)
Treat×Year2017 −0.0327
(0.0339)
Treat×Year2019 0.1136***
(0.0332)
Constant 2.9896*** −1.138 −2.1638** −0.722
(0.8148) (1.1595) (0.9654) (0.7916)
Firm fixed effects Yes Yes Yes Yes
Year fixed effects Yes Yes Yes Yes
N 10526 5593 10470 10526
R2 0.183 0.178 0.108 0.108
The table reports the results of sensitivity tests. The standard errors clustered at the firm level are reported in
parentheses. The symbols *, **, and *** denote significance at the 10%, 5%, and 1% levels, respectively.
12 H. LUO AND Y. WU

Table 4, the coefficient of Treat×Post is positive and significant at the 1% statistical level,
suggesting that environmental taxes promote green innovation.
Second, in the main regression, we set the counts to 0 when firms have no green patent
information in the CNRDS database, which may cause bias because some firms do not apply
patents for their technology. Following Chang et al. (2019), we exclude observations that have
zero green innovation and use Equation (1) to examine the impact of environmental taxes on
corporate green innovation. As shown in Column 2 of Panel A in Table 4, the results mean
that environmental taxes have a positive effect on corporate green innovation.
In addition, we further examine the impact of air quality. Air quality is an important
variable that may simultaneously affect green innovation and the implementation of the
Environmental Protection Tax Law. On the one hand, Wang et al. (2022) find that heavy
pollution makes firms tend to develop more green innovation. On the other hand, air
pollution attracts more attention from residents who urge the government to take action
to improve environmental protection, such as legislation and environmental taxes.
Therefore, the missing variables that measure air quality may drive the relationship
between environmental taxes and corporate green innovation. In Column 3 of Panel
A in Table 4, we control for the effect of air quality. Specifically, we use the natural
logarithm of the air quality index to measure air quality (AQI). As shown in Column 3,
the coefficient of Treat×Post is positive and significant at the 5% statistical level,
suggesting that the findings of this paper remain valid.
Finally, the parallel assumption should be satisfied when we use the DID method,
meaning that the numbers of patents trend closely in parallel for the two groups before
the Chinese Environmental Protection Tax Law. Following Xu et al. (2020), we regress
Equation (1) with dynamic dummies to formally test the assumption. Specifically, we
develop four dummy variables (Year2016, Year2017, Year2018, and Year2019). Then, we
generate the interaction between these dummy variables and Treat (Treat×Year2016,
Treat×Year2017, Treat×Year2018, and Treat× Year2019). Then, we use these interactions
to replace Treat×Post in Equation (1). The regression coefficients of Treat×Year2016 and
Treat×Year2017 should be insignificant when the parallel assumption is satisfied.6 In
Column 4 of Table 4, we find that the parallel trend assumption is satisfied.

5.4. Mechanism tests

The analysis in the previous sections identifies a significantly positive association
between environmental tax and corporate green innovation. In this subsection, we
explore the economic mechanism through which environmental taxes affect corporate
green innovation. Prior studies find that increasing taxes have a negative effect on
innovation activities. However, against this specific background, although environmental
taxes increase the corporate tax burden, we contend that to obtain resources and
potential opportunities, firms have an incentive to cater to the determination of govern­
ment environmental governance by green innovation to develop a close relationship with
the government. Different ownership structures have different abilities to access
resources and potential opportunities in China, which provides a chance to investigate
6
The interaction term of Treat×Year2018 is excluded from the regression because we use the interaction term as the
benchmark.
 JOURNAL OF APPLIED ECONOMICS 13

the economic mechanism through which environmental taxes affect corporate green
innovation. In China, the government plays an important role in resource allocation.
SOEs are controlled by the government and have a natural intimate relationship with the
government, which gives SOEs more advantages over non-SOEs (Hu et al., 2021). For
example, the Chinese bank sector controlled by state-owned banks prefers lending to
SOEs regardless of their profitability, leaving non-SOE credit constraints (Ayyagari et al.,
2010). In addition to banks, other financial institutions also prefer to provide funds for
SOEs, such as mutual funds (Yang et al., 2014). Therefore, to obtain the resources and
opportunities that determine firm operation, non-SOEs have more incentive to develop
green innovation to cater to government environmental governance compared to SOEs.
We divide firms into two subsamples according to corporate ownership, namely, SOEs
and non-SOEs. Then, we use Equation (1) to examine the impact of environmental taxes
on corporate green innovation. As shown in Table 5, the coefficient of Treat×Post is
positive and significant for non-SOEs, supporting the view that although environmental
taxes increase the corporate tax burden, firms are willing to engage in green innovation to
cater to government environmental governance.

5.5. Cross-sectional heterogeneity in results

5.5.1. The effect of product market competition
Production market competition may affect the relationship between environmental taxes
and corporate green innovation. Firms can set higher prices and receive higher profits in

Table 5. Mechanism tests.

SOEs non-SOEs
Patent Patent
Trea×Post 0.0323 0.0812**
(0.0525) (0.0337)
RD 3.038 2.7219*
(2.2863) (1.5339)
Size 0.1238** 0.0580
(0.0508) (0.0464)
Lev −0.234 −0.0379
(0.2129) (0.1274)
Cash −0.121 −0.152
(0.2974) (0.1797)
ROA 0.291 0.6720***
(0.3213) (0.2173)
Tangi 0.158 −0.4514**
(0.3197) (0.1778)
Age 0.0870 0.2236***
(0.1299) (0.0427)
Indep −0.198 0.311
(0.4339) (0.3513)
Duality 0.0124 0.0442
(0.0681) (0.0359)
constant −1.642 −0.835
(1.2122) (1.0194)
Firm fixed effects Yes Yes
Year fixed effects Yes Yes
N 3055 7463
R2 0.129 0.0998
The table reports the results of the mechanism tests. The
standard errors clustered at the firm level are reported in
parentheses. The symbols *, **, and *** denote significance
at the 10%, 5%, and 1% levels, respectively.
14 H. LUO AND Y. WU

a highly concentrated market (Bian, 1951), which makes these firms have more resources
and reduces their dependence on external resources. In addition, firms in a concentrated
market can transfer taxes to consumers, which lowers the impact of government policy
on firms’ operations. In contrast, in a fierce product market, to gain a competitive
advantage, firms have more incentive to cater to government environmental governance.
Therefore, we expect that product market competition affects the relationship between
environmental taxes and corporate green innovation. We use the Herfindahl index
(HHI) to measure product market competition.7 Then, we divide samples into two
subsamples by the median value of the index. As shown in Column 1 and Column 2 of
Table 6, environmental tax has a significant positive effect on corporate green innovation
in fierce market product competition.

5.5.2. The effect of financial constraints

Financial constraints are a key factor by which tax grants can promote corporate
innovations because tax grants alleviate financial constraints, making firms invest more
in innovation (Gorodnichenko & Schnitzer, 2013; Shao & Xiao, 2019; Wang & Kesan,
2022). However, the Chinese financial system is controlled by state-owned banks, and the
government can affect corporate green innovation through bank credit (Hu et al., 2021).
For example, to develop a sustainable economy, the Chinese government issued the
Green Credit Guidelines in 2012, which asked banks to provide preferred credit to firms
engaging in green operations. Therefore, firms facing strict financial constraints may
develop more green innovation to cater to government environmental taxes. Following
Chang et al. (2019), we use firm size to classify whether firms face larger financial
constraints. We partition the sample according to the median value of firm size. Larger
firms have fewer financial constraints than smaller firms. We conjecture that the associa­
tion between environmental taxes and corporate green innovation is more prominent for
firms with more strict financial constraints. As shown in Columns 3 and 4 of Table 6,
firms with more strict financial constraints engage in more green innovation.

5.5.3. The effect of marketization

In terms of marketization, there are tremendous differences across China. Eastern
regions have higher marketization (Fan et al., 2011; Tan et al., 2020), and some cities,
such as Shanghai, Guangzhou, and Shenzhen, have a similar degree of marketization as
developed countries.8 Higher marketization means that firms have more chances to
access external resources and reduce their dependence on government. In addition, the
government intervenes less in firm operations in regions with higher marketization
(Fang et al., 2017). Therefore, firms located in areas with higher marketization have
less incentive to engage in green innovation to cater to government environmental
governance. Following Tan et al. (2020), we divide our sample into two subsamples,
namely, firms located in eastern regions and firms located in other regions. We argue that
the relationship between environmental taxes and corporate green innovation is more
prominent for firms located in the low marketization regions, namely, non-eastern
7
We classify the manufacturing industry into more detailed industry categories using the 3 codes when we measure
production market competition.
8
Eastern regions include Beijing, Shandong, Jiangsu, Shanghai, Zhejiang, Fujian, Guangdong, and Hainan provinces.
Table 6. Cross-sectional analysis.
(1) (2) (3) (4) (5) (6)
High HHI Low HHI Lager firms Smaller firms High marketization Low marketization
Patent Patent Patent Patent Patent Patent
Treat×Post 0.1179*** 0.0423 0.0484 0.0765* 0.0436 0.1163**
(0.0415) (0.0412) (0.0423) (0.0397) (0.0347) (0.0481)
RD 1.007 4.9025** 7.6403*** −0.525 2.9448** 2.217
(1.7707) (1.9082) (2.2750) (1.5072) (1.4805) (2.5560)
Size 0.0928* 0.0654 0.0879 0.0598 0.0914* 0.0128
(0.0555) (0.0458) (0.0632) (0.0610) (0.0471) (0.0510)
Lev −0.0535 −0.0757 −0.0188 −0.0983 −0.194 0.158
(0.1689) (0.1485) (0.2105) (0.1292) (0.1333) (0.1867)
Cash −0.0880 −0.181 0.0245 −0.224 −0.0201 −0.402
(0.2225) (0.2107) (0.2593) (0.1852) (0.1872) (0.2615)
ROA 0.5078** 0.6863*** 1.0312*** 0.357 0.3699* 1.1406***
(0.2577) (0.2476) (0.3303) (0.2177) (0.2148) (0.3125)
Tangi 0.0724 −0.312 −0.321 −0.0619 −0.339 −0.0143
(0.2516) (0.2053) (0.3125) (0.1981) (0.2163) (0.2370)
Age 0.1991*** 0.1525*** −0.0160 0.1643*** 0.2020*** 0.1259*
(0.0542) (0.0544) (0.1041) (0.0480) (0.0439) (0.0764)
Indep 0.7875* −0.460 −0.493 0.7312* −0.0104 0.550
(0.4330) (0.3577) (0.3938) (0.3758) (0.3442) (0.4351)
Duality 0.0163 0.0630 −0.00320 0.0635 0.0336 0.0526
(0.0461) (0.0448) (0.0515) (0.0429) (0.0384) (0.0552)
Constant −1.662 −0.649 −0.503 −1.120 −1.269 0.0711
(1.2291) (1.0264) (1.4371) (1.2944) (1.0320) (1.1803)
Firm fixed effects Yes Yes Yes Yes Yes Yes
Year fixed effects Yes Yes Yes Yes Yes Yes
N 5212 5314 5263 5263 7129 3397
R2 0.120 0.102 0.152 0.0760 0.109 0.106
The table reports the results of cross-sectional heterogeneity. The standard errors clustered at the firm level are reported in parentheses. The symbols *, **, and *** denote significance at the
10%, 5%, and 1% levels, respectively.
JOURNAL OF APPLIED ECONOMICS
15
16 H. LUO AND Y. WU

regions. As shown in Columns 5 and 6 of Table 6, we find that environmental tax has
a positive and significant effect on corporate green innovation in the low marketization
regions.

5.6. Additional analysis

In this section, we run two additional analyses. First, we examine whether environmental
taxes improve corporate green innovation efficiency. Following Chang et al. (2019), we
use the natural logarithm of one plus the total green invention patents and green utility
model patents over R&D expenditures to measure corporate green innovation efficiency
(Efficiency), which captures a firm’s ability to generate green patents per R&D expendi­
ture. In Column 1 of Table 7, we find that environmental taxes improve corporate green
innovation efficiency.
Second, we examine the impact of environmental taxes on different types of green
innovation, namely, green invention innovations and green utility model innovations.
We use the natural logarithm of one plus the number of green invention patent applica­
tions to measure green invention innovations (Invention) and the natural logarithm of
one plus the number of green utility model patent applications to measure green utility
model innovations (Utility). According to Chinese patent law, invention patents have the
highest number of novel technologies and are granted a new technological solution
relating to a process, a product, or an improvement. Utility model patents have fewer

Table 7. Additional analysis.

(1) (2) (3)
Efficiency Invention Utility
Treat×Post 0.0098** 0.0396 0.1061***
(0.0044) (0.0249) (0.0236)
RD 0.0107 2.3110* 0.615
(0.1406) (1.1832) (0.9866)
Size −0.0227*** 0.0926*** −0.0277
(0.0053) (0.0325) (0.0295)
Lev −0.0104 −0.0785 −0.0211
(0.0180) (0.0976) (0.0922)
Cash −0.0795*** −0.00440 −0.2359*
(0.0263) (0.1319) (0.1325)
ROA 0.0545* 0.6111*** 0.3113**
(0.0326) (0.1594) (0.1531)
Tangi −0.0228 −0.00160 −0.3512***
(0.0300) (0.1464) (0.1320)
Age 0.00830 0.0855*** 0.2528***
(0.0055) (0.0328) (0.0315)
Indep −0.0706 0.0423 0.194
(0.0441) (0.2402) (0.2475)
Duality −0.0007 0.0383 0.0019
(0.0043) (0.0276) (0.0263)
Constant 0.5866*** −1.5743** 0.835
(0.1205) (0.7208) (0.6602)
Firm fixed effects Yes Yes Yes
Year fixed effects Yes Yes Yes
N 10334 10526 10526
R2 0.0540 0.0358 0.183
The table shows the results of additional analysis. The standard errors clustered at the
firm level are reported in parentheses. The symbols *, **, and *** denote significance
at the 10%, 5%, and 1% levels, respectively.
 JOURNAL OF APPLIED ECONOMICS 17

novel technologies and are granted for new and practical technical solutions relating to
the shape and/or structure of a product. In Columns 2 and 3 of Table 7, we find that
environmental taxes fail to affect green invention innovations but promote green utility
model innovations. This may be because green utility model innovations need fewer
resources to develop than green invention innovations, which means that enterprises can
cater to the demand of governments for green patents in a short time with few resources.

6. Discussion
6.1. Conclusion
In this paper, we examine how environmental taxes affect corporate green innovation. To
address potential endogeneity issues, we explore the enactment of the Chinese
Environmental Protection Tax Law in 2018 as a quasinatural experiment. (1) Using the
DID method, we document that environmental taxes promote corporate green innovation,
which is different from the findings of prior studies that argue that increasing the tax
burden hampers innovation activities. (2) The finding is valid for replacing the measure of
green innovation, excluding observations with zero green innovation output, controlling
the impact on air quality, and testing the parallel trend assumption of the DID method. (3)
Mechanism tests find that firms engage in green innovation to cater to government
environmental governance. (4) Cross-sectional heterogeneity analyses find that the asso­
ciation between environmental tax and corporate green innovation is more prominent for
firms within intense product market competition, firms with strict financial constraints,
and firms located in higher marketization regions. (5) Addition analyses find that environ­
mental tax has a significant effect on corporate green innovation efficiency and green utility
model innovations but fails to affect green invention innovations.

6.2. Policy implications

The evidence provided in this paper has important policy implications for policy-makers
who want to stimulate green innovation. To stimulate green innovation and achieve
sustainable development, the government can consider the following advice:

(1) The government should improve the cultivation of enterprises’ environmental

awareness. The finding that firms engage in green innovation to cater to govern­
ment environmental governance means that obtaining resources controlled by the
government drives firms to develop more green innovation and that firms have
less incentive to voluntarily adopt green innovation. Improving enterprises’ envir­
onmental awareness can induce enterprises to actively reduce the impact of firms’
operations on the environment.
(2) Meanwhile, this paper finds that the impact of environmental taxes on green
innovation is less prominent in regions with higher marketization. Firms that have
more chances to access external resources fail to achieve the aim of the
Environmental Protection Tax Law. To promote corporate green transformation,
18 H. LUO AND Y. WU

the government can consider raising environmental taxes in these regions and
improving the enforcement of environmental tax laws. These measures can
increase the constraint of environmental taxes and make firms located in areas
with lower marketization have more incentive to develop green innovation.

6.3. Limitations and further research directions

Notably, this paper provides limited mechanisms to explain how environmental taxes
affect corporate green innovation. Taxes, an important policy tool, may affect corporate
innovation through many channels. Further research can provide more mechanism tests
to identify how environmental taxes affect corporate green innovation. In addition,
patents are one of the important ways that firms protect innovation outputs. Firms
also keep innovation outputs secret, which makes patent data fail to reflect total innova­
tion outputs. Therefore, further analysis can help find a better measurement of innova­
tion outputs.

Disclosure statement
No potential conflict of interest was reported by the author(s).

Notes on contributors
Haohan Luo is a lecturer in the Business School at Chengdu University of Technology. He majored
in finance and obtained his Ph.D. degree from the Southwestern University of Finance and
Economics. His research is primarily on wealth management and tourism management.
Ying Wu is a lecturer in the School of Business at Nanjing Normal University. He majored in
finance and obtained his Ph.D. degree from the Southwestern University of Finance and
Economics. He is interested in corporate governance and China’s economy.

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