Green taxes: Productivity effects of tax-based environmental regulations on heavily polluting firms

Environmental regulations, particularly tax-based measures, significantly impact firm productivity and corporate behavior. This study uses China's Environmental Protection Tax (EPT) law as a quasi-natural experiment to explore whether and how such tax-based environmental regulations influence the productivity of heavily polluting firms. Using a difference-in-differences approach, we find that the EPT law has positively impacted firm productivity by fostering higher research and development investments and encouraging the substitution of labor with capital. The productivity-enhancing effect is more pronounced for state-owned enterprises, large firms, firms with fewer financial constraints, firms receiving more government subsidies, and firms operating in less competitive sectors. These findings support the Porter hypothesis, suggesting that well-designed environmental regulations can stimulate innovation and improve competitiveness, ultimately enhancing productivity. This study underscores the importance of tax-based environmental regulations in promoting productivity and economic growth, providing valuable insights for policymakers aiming to balance environmental protection with economic development. •Environmental protection tax (EPT) can have either positive or negative effects on firm productivity.•We find EPT law increases high-polluting firms' productivity.•R&D investment and labor substitution by capital drive the gains.•State-owned, large, and less financially constrained firms benefit most from EPT law.•Improved productivity boosts the valuation of high-polluting firms.