Tax credits and total factor productivity: firm-level evidence from Taiwan

We studied the effect of tax policy on the productivity of Taiwanese manufacturing firms from 2001 to 2008. First, we investigated the determinants of firm decisions on tax credit applications. By employing the dynamic random effect probit model, this study demonstrated that past tax credit use has exerted a causal effect on current tax credit use across various industries. Specifically, there has been a persistence use of tax credit among manufacturing firms in Taiwan. Second, we employed the panel instrumental variable approach to control for tax credit endogeneity and firm heterogeneity in determining firm productivity. The results indicated that firms’ tax credit use produced a positive and statistically significant effect on productivity. Finally, after categorising the firms as either electronics or non-electronics businesses, we observed that the marginal effect of tax credits has been associated with the productivity of electronics firms. This study demonstrated that tax credit use among Taiwanese firms has enhanced their productivity. This indicates that effective tax policy can promote national economic growth.