Notching R&D Investment with Corporate Income Tax Cuts in China

We study a Chinese policy that awards substantial tax cuts to firms with R&D investment over a threshold or notch. -Quasi- experimental variation and administrative tax data show a significant increase in reported R&D that is partly driven by firms relabeling expenses as R&D. Structural estimates show relabeling accounts for 24.2 percent of reported R&D and that doubling R&D would increase productivity by 9 percent. Policy simulations show that firm selection and relabeling determine the -cost-effectiveness of stimulating R&D, that -notch-based policies are more effective than tax credits when relabeling is prevalent, and that modest spillovers justify the program from a welfare perspective.

Automated summary

The study reveals that under a Chinese policy, firms receive substantial tax cuts by relabeling expenses as R&D, leading to a significant increase in reported R&D. Structural estimates show that relabeling accounts for 24.2% of reported R&D, and doubling R&D would increase productivity by 9%.