Did the pollution charge system promote or inhibit innovation? Evidence from Chinese micro-enterprises

Studying the impact of the former Pollution Charge System (PCS) on enterprise innovation will provide a reference for China to improving the current environmental protection tax system (EPTS). Based on innovation panel data and the sewage charges applied to polluting enterprises in China, this paper empirically analyzes the impact of the PCS on enterprise innovation. The results show that the PCS significantly inhibits the patent output of enterprises. The study analyzes heterogeneity in these findings in three respects: enterprise scale, enterprise ownership, and regional development level. The results are as follows: 1) The PCS has a greater inhibitory effect on smaller enterprises' innovation than on larger enterprises; 2) The inhibitory effect on non-state-owned enterprises' innovation is greater than on state-owned enterprises; 3) The inhibitory effect is greater for enterprises located in western regions of China. We also use a difference-in-differences strategy to address endogeneity concerns. The mediation analysis finds that the mechanism of the PCS affecting innovation is to reduce enterprise cash flow and R&D expenditure.