Direct Tax Burden, Financing Constraints, and Innovation-Based Output

Round 1

Reviewer 1 Report

Please see attachment.

Comments for author File: Comments.pdf

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Author Response

We thank you for your insightful and constructive comments. We have revised the paper to address your concern. We have tracked the changes and insertions that were made to the last version. We discuss our response to the points raised in your review below. (Your comments are shown in italics.)

Concern #1. Variables

1.The direct tax burden is measured by income tax, which may be subject to misinterpretation.

Could you please explain why this measurement was chosen and preferred over the other

measurements in prior literature?

Thank you very much for your comments. Please see paragraph 3, page 2 (mark in red).

In 2020, China's corporate income tax revenue will account for 3.59% of GDP, which is also higher than some developed countries such as the United States (0.96%), the United Kingdom (2.49%), Germany (2.01%) and France (2.24%). According to the Fiscal Revenue and Expenditure in 2022 released by the Ministry of Finance in January 2023, it is found that income tax accounts for 65% of the total direct tax burden, and other types of direct tax burden are not enough compared with the corporate income tax, and the corporate income tax shows a slight increase in 2022, with a year-on-year growth of 3.9%, although the overall corporate income tax is growing. However, the overall trend of corporate income tax burden is decreasing, although compared with OECD members, China's income tax burden still has room to decrease.

Therefore, the direct tax burden is exempted based on the above reasons.

 

2.Regarding the measurement standard of innovation output, this paper uses the number of

patent applications to measure the innovation output. However, the number of patents

granted does not capture the quality of patents and the economic consequences resulting

from the patents.

Thank you very much for your comments. This paper uses the quantity and quality of innovation to measure corporate innovation. In the main regression, we use the number of patent applications to measure innovation output. Please see page 7, Research design-(2) Variable definition-1. Explained variable (innovation output). In the robustness test, the number of patent authorizations is used to measure the quality of patents. Please see page 11, 2. Replacement of variable measurement.

 

Concern #2: Hypothesis The paper argues that tax burdens increase innovative output by easing

both internal and external financial constraints, but there are some theoretical arguments that raise concerns. First, the channels depicted in Figure 1 appear inconsistent with the arguments presented in Section 2.3, which may confuse readers. Second, given that some tax reduction policies incentivize high-tech firms to increase R&D spending, firms have incentives to engage in innovation activities (Chen et al., 2021b). Therefore, the paper should clarify that some tax policies target firms with high R&D intensity as the channel through which tax cuts promote innovation.

Thank you for this suggestion.

Protect human capital, reduce financing costs and reduce the risk of principal-agent correspond to Direct Tax Burden, Financing Constraints and Innovation Output on page 5 (Mark in red). The specific correspondence is as follows.

Protect human capital

In addition, financing constraint mitigation can also help enterprises to protect their human capital, especially for the key talents of decision-makers and implementer of innovation activities, which can help enterprises to improve innovation efficiency and increase the quantity and quality of innovation output (Grieser and Liu, 2019; Dou et al., 2021). See Page 5-6

Reduce financing costs——That is, when the financing constraints are reduced, enterprises will increase their innovation output (Brown et al., 2012). See Page 5

Reduce the risk of principal-agent——Gertler (1992) pointed out that in an imperfect capital market, information asymmetry and agency problems will lead to financing constraint problems for enterprises, and the investment behavior of enterprises will not only be affected by investment demand, but also by enterprise capital. See Page 5

 

Mitigate the adverse effects of reduced credit, Increase after-tax yields and Alleviate information asymmetry corresponds to Page 6. The specific correspondence is as follows.

Increase after-tax yields——However, when government releases tax policies related to innovation activities, tax reduction will increase the after-tax rate of return of enterprises. See Page 6.

Alleviate information——which will send a positive signal and alleviate the problem of information asymmetry in innovation activities (Bakker et al., 2013). See Page 6.

Mitigate the adverse effects of reduced credit——The expansion of external financing channels alleviates the adverse effects caused by banks' loan reduction behavior, and helps enterprises solve the problem of stagnation of innovation activities caused by insufficient funds, thus increasing the innovation output (Rao, 2016; Mukherjee et al., 2017; Chen et al., 2019; Shao et al., 2019). See Page 6.

 

Increase internal cash flow and profit margin and Ease financing constraints corresponds to Page5-6. The specific correspondence is as follows.

Increase internal cash flow

Deng (2021) thought that the more disposable free cash flows an enterprise has, the more likely it will be to carry out innovative activities spontaneously, so as to improve its innovative output. On the contrary, when an enterprise's disposable cash flow is insufficient, carrying out innovative activities will increase the risk of capital chain breakage, so it may not be a rational choice for enterprises to carry out innovative activities at this time, and enterprises will give up innovative activities to ensure the normal operation of enterprise capital chain. According to the pecking order theory, when an enterprise carries out innovation activities, it will give priority to the internal financing method with lower cost to carry out innovation activities, reduce the direct tax burden and increase the free disposable cash flow of the enterprise, thus slowing down the internal financing constraints of the enterprise, and ultimately affecting the vitality of innovation output. See page 6

Increase internal cash flow and profit margin

In the study of Dou et al. (2022), it is also shown that after the implementation of tax reduction policies in the US Job Creation Act, the degree of competition in the market is alleviated. This is because the extra tax burden can lead to the deterioration of financing constraints through the mechanism of product market competition. So that enterprises do not have enough funds to carry out innovative activities. Product market competition channels help amplify the impact of changes in the tax burden, and this impact is critical because it offsets the positive effect of free cash flow. Therefore, reducing the direct tax burden of enterprises can increase the discretionary cash flow of internal managers, reduce the internal financing constraints, and promote enterprises to carry out innovative activities (Yigitcanlar et al., 2019; Freitas et al., 2017; Auerbach et al., 2018; Hall, 2000, Kang et al.,2023) to reduce business risks. See page 6

 

Thank you for this wonderful comment. Some tax policies target companies with high R&D intensity as a channel for tax reduction to promote innovation. This paper attributes this kind of incentive effect to increasing after-tax returns and sending positive signals. It is precisely because the spread of these positive signals gives other companies the motivation to carry out innovative activities and promotes companies to carry out innovative behaviors, so this paper does not list them separately. See Paragraph 3 Page 6.

 

Concern #3. Endogeneity 

First, Gao et al. (2016) found that firms with higher levels of innovation are

more likely to engage in tax avoidance. Hence, the association found in the paper may suffer from

inverse causality problems. The paper should explore additional approaches to mitigate this problem.

Second, considering China's unique institutional setting where tax burdens have been significantly

reduced, the paper should consider utilizing these settings to study the association and establish

reliable causal link.

Thank you for this great suggestion.

In order to solve the possible reverse causality problem, following Li et al. (2018) and Liu et al. (2020), using the average comprehensive tax burden of enterprises in the same city and industry as the instrumental variable of tax burden (IV), and the instrumental variables satisfy the exogeneity and correlation conditions. In terms of exogeneity, the results are significant. See Page 12 (3) Robustness test.

According to the latest "2021 Income Statistics Report" released by the Organization for Economic Cooperation and Development (OECD), there is still room for reduction in my country's income tax burden compared with OECD members. Taking into account China's unique institutional environment, although the tax burden has been significantly reduced, there is still room for reduction. Therefore, this article uses these environments to study their correlations and establish reliable causal relationships. (See third paragraph Page 2 Mark in red)

 

Concern #4. Other issues

1. The paper lacks discussion on the selection of sample period.

The sample scope was selected in 2010 because the Development and Reform Commission of the State Council issued the "Opinions on Key Works for Deepening Economic System Reform in 2010", which for the first time reflected the major direction of my country's future tax reform - gradually increasing the proportion of direct taxes (See Page 3).

In the robustness test, 2013 was selected as the starting sample because my country has entered a period of comprehensively deepening reform since 2013, and tax reform has been comprehensively deepened and a series of important progress has been made. It is proposed to improve the local tax system, gradually increase the proportion of direct taxes, and increase the tax status of direct taxes in my country. Therefore, the original sample range starting in 2010 is reduced to the sample range starting in 2013. (See Page 6. Method of changing sample size).

 

 

2. The sample size is reported as 11,000 in the research design and descriptive statistics, but in the result tables, the sample size is listed as 11,283. The authors should explain this discrepancy.

Because the variables SOE and CorGovindex are added to the descriptive statistics, there are missing values. However, in the main regression, these two variables SOE and CorGovindex do not exist. Therefore, in the research design and descriptive statistics, the sample size is reported as 11,000, but in the results table, the sample size is listed as 11,283. (See Appendix Table1)

 

3. Variable definitions and calculations should be in Appendix, not Table 1.

The variable definition table has been placed in the appendix.

 

4. The paper needs to a through edit to make the expression consistent. For example “Finally, in order to control the influence of year and industry, this paper adds year and industry dummy variables to the model.” “this paper adopts the method of adding the fixed effect of year and industry into the regression model to avoid the influence of missing variables.”

Thank you very much for your excellent suggestion. Page 8, 4. In Control variables, change Finally, in order to control the influence of year and industry, this paper adds year and industry dummy variables to the model to this paper adopts the method of adding the fixed effect of year and industry into the regression model to avoid the influence of missing variables. See Page 8

 

 

 

Reviewer 2 Report

Good day.

In Figure 1, the authors present the Mechanism of the direct tax burden on innovative activities of enterprises. It would be appropriate to show the interrelationship of technologies, tools, methods and methods that affect the object and lead to the coordinated, effective operation of the entire system.

Author Response

Thank you very much for your comments. We have added the following sentences to p. 6:

To sum up, the impact of the reduction of direct tax burden on the alleviation of corporate financing constraints can be divided into two perspectives. From the perspective of internal financing constraints, the internal financing constraints of enterprises can be alleviated by increasing the internal cash flow of enterprises and alleviating the additional market competition caused by the shortage of funds. From the perspective of external financing constraints, the reduction of direct tax burden can send a positive signal to the outside world, alleviate the information asymmetry of enterprises, increase investor confidence, alleviate the adverse impact of the reduction of bank credit, and achieve the purpose of easing the external financing constraints of enterprises. When financing constraints of enterprises are reduced, enterprises have more disposable funds, which can be used to retain innovative talents, reduce innovation stagnation caused by financing costs, and reduce innovation risks caused by principal-agent problems, so as to ultimately achieve the purpose of increasing innovation output of enterprises. The mechanism is shown in Figure 1.

Author Response File: Author Response.docx

Reviewer 3 Report

This text discusses an intriguing topic.   Firstly, it is necessary to provide more authoritative literature support for the mechanism depicted in Figure 1. Additionally, there is a need to clarify the negative impact of lowering direct taxes.

It is fine.

Author Response

Thanks for your wonderful comments. Firstly, we have added some literature on page 6. Brown et al., 2012; He et al.,2023; Atanassov, 2020; Castellacci and Lie, 2015; Chen and Yang, 2019; Silber,1983; Mansfield,1982; Kang et al.,2023; Gorodnichenko and Schnitzer, 2013. We also have added them in reference list (with tracked changes). Please the references on pages 20-21.

 

James, R. Brown.; Gustav,Martinsson. Bruce,C.Petersen. Do financing constraints matter for R&D?Eur.Econ.Rev. 2012, 56(8): 1512-1529.

Lerong,He.; Xiao, zhen.Jiang.; Liting,Fang. Tax policy reform and corporate innovation in China. Financ.Res. Letters. 2023,55(A): 9-16.

L, Chen.; W,Yang. R&D tax credits and firm innovation: Evidence from China Technol. Forecast Soc Change, 2019, 146: 233-241.

Fulvio,Castellacci.; Christine,Mee.Lie.Do the effects of R&D tax credits vary across industries? A meta-regression analysis. Res.Policy. 2015, 44 (4):819-832.

Atanassov.; X,Liu. Can corporate income tax cuts stimulate innovation? Int.Rev.Financ.Quantit.Anal.2020,55 (5):1415-1465.

William, L. Silber.The process of financial innovation.Ame. Econ. Rev.1983,73(2):89–95.

Fengli,Kang.; Qiaomao,Yu.; Mengfei,Wan.Corporate innovation incentive policy during business cycles: Fiscal subsidies or tax incentives? Emerging Markets Finan.Trade.2023, 59(7): 2190-2203. 

Yuriy, Gorodnichenko.; Monika,Schnitzer.; Financial constraints and innovation: Why poor countries don’t catch up. J. Eur. Econ. Assoc.2013,11(5):1115–1152.

E, Mansfield.Tax policy and innovation.Econ.Science.1982,215:1365-1371.

 

Secondly, in the second paragraph on page 4 (Mark in red), this paper describes the possible adverse effects of lower tax burden as follows:

Second, tax policy and innovation activities of enterprises can't play a promoting role. For example, Wei et al. (2018) thought that for small and micro enterprises, obtaining preferential tax policies can improve the profits of enterprises, but it has no influence no innovation activity of enterprises. And Krugman (2016) believed that preferential tax policy is not an effective measure to address the lack of incentives in innovative markets. Generally speaking, most scholars support the first view.

We also have added the following sentences to Page 4.

Li (2020) and Tirole (2006) believed that after the promulgation of tax reduction policies, enterprises may take targeted measures according to tax policies, which will inhibit enterprises' innovation behavior.

Author Response File: Author Response.docx

Reviewer 4 Report

Dear Author

Overall the article is good, but it can be improved further in the following way:

1. Use proper theory from economics to establish the problem of the study, as I am unable to link theoratically the dependent and independent variables of the study.

2. Discuss the results of the study with thethe help of theoratical support. 

3. Add managerial implications of this study.

4. Add limitations and future directions for further research.  

Author Response

We thank you for your insightful and constructive comments. We have revised the paper to address your concern. We have tracked the changes and insertions that were made to the last version. We discuss our response to the points raised in your review below. (Your comments are shown in italics.)

1. Use proper theory from economics to establish the problem of the study, as I am unable to link theoratically the dependent and independent variables of the study.

We have added the following economic theory at the end of the last paragraph on page 3.

The classical tax reduction theory, the Keynesian tax reduction theory and the supply-side tax reduction theory all aim to achieve the ultimate goal of stable economic growth through tax cuts. The difference lies in the tax reduction policies implemented in different times to solve various problems. Keynesians and supply-siders use tax cuts to stimulate demand and improve supply. The main purpose of the current series of supply-side structural reforms in China is to reduce the production cost on the supply side, optimize the supply structure, promote the reform and innovation on the supply side, and then achieve economic growth.

2. Discuss the results of the study with thethe help of theoratical support. 

We have added theory analysis in result discussion as follows.

Page 11

when the direct tax burden borne by enterprises is reduced, enterprises have more free cash flow, and there will be more opportunities to carry out innovative activities with uncertain risks, thus increasing the innovation output of enterprises (Giroud and Rauh, 2019; Mukherjee et al., 2017)

This is because the reduction of the direct tax burden alleviates the internal and external financing constraints of enterprises by sending positive signals to the outside world, alleviating the adverse impact of the reduction of bank credit, and increasing internal cash flow and profit margins.

It shows that financing constraints are an important obstacle to enterprise innovation, and easing financing constraints can promote the innovation output of enterprises by reducing financing costs and protecting human capital (Brown et al., 2012).

Page 15-16

This is because compared with non-invention patents, the technical content contained in invention patents and the help to the future development of enterprises will be significantly higher than that of non-invention patents. When the financing constraints faced by enterprises are eased due to the reduction of direct tax burden, in order to break the existing dilemma and promote sustainable development, firms are more likely to apply for invention patents with more technical and can lay the foundation for future development.

Page 17

In non-state-owned enterprises, due to the absence of "soft constraints" on primary objectives and budgets, the financing constraints faced by enterprises are more obvious than those faced by state-owned enterprises.

The reduction of direct tax burden can send a positive financial signal to the outside world. Compared with enterprises with high corporate governance level, enterprises with low governance level have more serious financial problems and low innovation output due to information asymmetry and agency problems. Therefore, when the direct tax burden is reduced, stakeholders can obtain the tax reduction situation of enterprises and the specific situation of part of the capital flow through channels, alleviate the above problems, and urge enterprises with low governance level to innovate and seek development in the fierce competitive environment.

3. Add managerial implications of this study.

We have added the managerial implications in Conclusion on p.20.

This paper has the following implications for further implementing the tax reduction. For one thing, maintaining the sustainable development of enterprises is an inevitable measure to achieve high-quality economic development in China. The conclusion of this paper further confirms the positive role of tax reduction policy in the current development stage in China, and provides reference for companies to use tax reduction policy to promote sustainable development. For the other thing, further increasing tax cuts for non-state-owned enterprises and reducing the burden on non-state-owned enterprises is powerful to accelerate and promote economic growth. Reducing the tax burden of non-state-owned enterprises can effectively expand internal demand and empower non-state-owned enterprises’development.

 

4. Add limitations and future directions for further research.  

We have added limitations and future directions for further research in Conclusion on p.21.

The limitation of this paper is that only income tax is used as the measurement index of direct tax burden, and other taxes are not included. However, since income tax accounts for more than 65% of direct tax burden, other taxes are too dispersed and occupy a relatively small proportion, so it has little impact on this study. It is hoped that the direct tax burden can be measured in a more accurate way in later research.

Author Response File: Author Response.docx

Round 2

Reviewer 1 Report

The authors have addressed my concerns raised in my report.

The authors must have the paper thoroughly proofread by a professional proofreader to improve the writing quality before the paper can be published. There are also numerous language errors in the paper. 

Author Response

Dear Reviewer

Thanks. We have proofread the whole paper by a professional proofreader.

Author Response File: Author Response.docx