Environmental Protection Tax and Firms’ ESG Investment: Evidence from China

Does environmental protection tax (EPT) improve firms’ environmental governance performance? Previous studies ignore that EPT affects firms' environmental governance behavior by increasing discharge and non-compliance costs. To fill this gap, we estimate the impact of EPT on firms' environmental, social, and governance (ESG) investments using Chinese listed firms during 2013-2020. we propose two key hypothesises: "Hypothesis 1A. EPT increases the firm’s green-producing and green-responsibility investment" and "Hypothesis 1B. EPT improves the quality of a firm’s environmental information disclosure". We estimate the impact of EPT on firms' environmental, social, and governance (ESG) investments using Chinese listed firms during 2013-2020. To evaluate firms’ ESG activities, we construct specific E, S, and G indicators relating to the environment, including the firm’s green-producing investment, green responsibility investment, and environmental information disclosure, which highlight the key impact of EPT on firms’ environmental governance. The three dimensions (E, S, and G) of ESG are often considered independent in most studies. but they can be relevant on an environmental level, reflecting the different ways in which corporate environmental governance is conducted. EPT is measured at the firm level using pollution discharge fees from 2013 to 2017 and pollution discharge taxes from 2018 to 2020. We find that EPT significantly forces firms to engage in more ESG activities after controlling for firm characteristics, firm-level, and year-level fixed effects. Our findings are robust to IV approaches, Heckman Correction, panel Generalized Method of Moments (GMM) estimations, an alternative EPT measure (EPT standards at the prefecture-level city), and ESG measures (ESG scores from a third party), as well as a group test. We also investigate the channel through which EPT boosts firms' ESG activities. One is an increasing tax payment as polluting discharges increase. The other is the ex-post noncompliance cost because EPT imposes strict penalties on violators, it includes illegal costs, negotiation costs, and litigation costs. We find that EPT has a positive impact on ESG in firms with greater cost pressure, which is measured by highly polluting industries and experiences with environmental controversy. Furthermore, we find that the ESG improvements are more significant in firms that are privately controlled, located in areas with sound environmental protection justice, and have weaker competitiveness.