Unintended effects of tax-sharing adjustments on firms' pollution emissions: Evidence from China

The impact of tax-sharing adjustments on firms' pollution emissions is theoretically unclear. Exploiting a quasi-natural experiment generated by the corporate tax collection reform in China, this study discerns a causal relationship between tax-sharing adjustments and firms' pollution emissions. Our findings reveal that a reduction in the local retention rate of tax-sharing revenue is associated with a significant decline in firms' pollution emissions. The mechanisms elucidate that, when the local retention rate of tax-sharing revenue decreases, local governments tend to strengthen environmental enforcement through the collection of pollution fees, inspection of violations, and imposition of environmental penalties. Notably, the pollution-reducing effects are more pronounced in the eastern regions, where corporate income tax losses are highest, or in the two control zones with a higher cost of incomplete environmental enforcement. Conversely, these effects are less pronounced for real estate firms, which can provide revenues to compensate for local corporate income tax losses. Our results suggest that partially reducing the tax nexus between local governments and local firms can to some extent contribute to improvements in environmental quality.