Do intergovernmental transfers accelerate the formation of zombie firms? A study based on fuzzy regression discontinuity analysis

Intergovernmental transfers are an important source of revenue for local governments, while governments’ revenue and expenditure practices are considered to be a deep-seated cause of zombie firm formation. Based on Chinese county-level panel data from 1999 to 2007, this study employs a policy experiment on the qualification for classification of China's national poverty counties in 1994 and analyzes the impact and mechanism of intergovernmental transfers on the formation of local zombie firms using the fuzzy regression discontinuity method. It is found that the proportion of local zombie firms will increase by 0.7 units and 3.2 units, respectively, when the share of general and earmarked transfers increases by 1 unit, confirming that intergovernmental transfers contribute to the formation of zombie firms. The results remain robust to different zombie firm identification methods. Further analysis also demonstrates that when local governments receive fiscal transfer payments with less autonomy, tax effort will increase, which eventually affects firms’ production and operations. The subsequent higher total burden caused by the increased tax collection and management leads to the formation of zombie firms. This study proposes a theoretical construct and intuitive evidence for accelerating the elimination of zombie firms and improving the fiscal transfer system in China.