Tax Incentives, Domestic Production Network and Exports

【Authors】

CAI Hongbo, MAO Jian & TANG Chengjian

【WorkUnit】

CAI Hongbo, MAO Jian （Beijing Normal University, 100875）；TANG Chengjian （Xi’an Jiaotong University, 710049）

【Abstract】

Since the 2008 global financial crisis, China’s international trade environment has faced rising uncertainty, with trade protectionism disrupting global industrial and supply chains through non-economic factors. As a major manufacturer and exporter in the world, China has experienced heightened export instability. Meanwhile, its domestic value chain has expanded rapidly, emerging as a key driver of sustainable growth. China’s industrial and supply-chain network, spanning many industries, has created a large-scale, tightly integrated production system with significant effects on corporate behavior. From 2007 to 2016, China’s average corporate income tax rate fell by 35%. While large tax cuts can stimulate production and demand, they also reduce fiscal revenue, expand deficits, and complicate transfer payments. In recent years, fiscal expenditure has risen alongside increased enterprise support, while revenues have declined, further widening the fiscal gap. Thus, targeted tax incentives for key industries present a practical approach to maximizing policy effectiveness and improving fiscal efficiency.
Drawing on the indicator construction methods of Aghion et al. （2024） and Barattieri et al. （2023）, this study uses a supply-chain database for Chinese listed firms matched with tax survey data, calculates tax-incentive impacts on their upstream and downstream industries, and addresses potential endogeneity. Combining the 2007-2016 National Enterprise Tax Survey data, the China Customs Database, and listed-firm supply-chain data, we construct upstream and downstream tax-shock indicators for midstream firms. Our analysis shows that downstream tax cuts increase demand for midstream firms, attract market entrants, and intensify competition. Midstream firms respond through innovation and cost reduction, ultimately boosting exports. Further decomposition shows that downstream tax cuts lead midstream firms to reallocate resources toward core products, and heightened competition pressures from market entrants drive incumbents to enhance competitiveness and quality. Mechanism tests confirm greater export competitiveness via innovation and cost control. By contrast, upstream tax incentives show no significant export impact, mainly due to high industry concentration and stronger market power, which allow upstream firms to absorb most tax-cut benefits.
This paper makes three contributions. First, it examines domestic demand’s role in China’s export growth within a production-network framework at a micro level, supporting the “domestic-factor theory” and enriching existing literature. Second, it assesses tax incentives via supply-chain exposure, enabling thorough evaluation of tax-reduction policy effects. Third, it identifies the transmission mechanism by which tax shocks propagate along supply chains to drive midstream exports. The identified heterogeneous effects can help policymakers refine tax incentives, targeting key sectors to maximize policy effects in stabilizing foreign trade and promoting structural adjustment. Our policy recommendations include refining targets, ensuring supply-chain security, promoting fair competition, and strengthening the role of fiscal policy in building a new pattern of development. Future research can explore heterogeneous responses across firms and industries to further improve tax-policy design.

JEL: H25, F14, L16

【KeyWords】

Tax Incentives, Domestic Production Network, China’s Export Growth, Exports