Unintended consequences of tax enforcement on corporate innovation: Evidence from a natural experiment in China

The impact of tax enforcement on innovation is examined in this research. This paper employs the merger of Local Tax Bureaus (LTBs) and State Tax Bureau (STB) in 2018 as an exogenous shock to stricter tax enforcement. We find that stricter tax enforcement can foster innovation within firms. A mechanism analysis shows that the enhancement in a firm’s innovation is motivated by the increased governance level, that is constraining the bribery and violation behavior of managers, motivated by stricter tax enforcement. According to heterogeneity research, this effect is more significant in SOEs and firms with weaker internal governance (i.e., firms with weak internal control and less independent directors) and firms with poor external governance environment (i.e., firms with lower media attention). Overall, this study empirically examines how tax enforcement affects innovation, which is crucial for boosting productivity and promoting economic growth.