Governments’ Fiscal Squeeze and Firms’ Pollution Emissions: Evidence from a Natural Experiment in China

We investigate whether and how government fiscal squeeze affects local firms’ pollution emissions. To establish causality, we introduce a policy shock in China, namely, the canceling of agricultural taxes in 2005, to document that governments’ fiscal squeeze due to sudden tax decreases substantially increases local firms’ emission by approximately 4%. Mechanism analyses show that local fiscal squeeze result in aggravating pollution emissions through inducing the reduction of firms’ efforts on green innovation and abatement activities. Cross-sectionally, the effects of local government fiscal squeeze on pollution emissions are mitigated by environmental regulation, marketization development, but strengthened by firm financial pressure.