Taxing for Good: How Tax Incentives Drive ESG Excellence in Chinese Firms

As a form of economic incentive, tax incentives can theoretically have a profound impact on corporate ESG performance by reducing the costs associated with fulfilling corporate social responsibilities and stimulating firms’ intrinsic motivation for sustainable development. This study examines the impact of tax incentives on corporate ESG performance and its potential underlying mechanisms using a sample of Chinese A-share listed companies from 2009 to 2023. The empirical results indicate that tax incentives significantly enhance corporate ESG performance—firms receiving higher levels of tax incentives exhibit better ESG performance. This conclusion remains robust after a series of robustness tests. Further analysis reveals that the positive effect of tax incentives is more pronounced in the environmental and governance dimensions of ESG. Additionally, we find substantial heterogeneity in the impact of tax incentives on ESG performance. Specifically, the beneficial effects of tax incentives are more significant for state-owned enterprises, firms with weaker financial performance, and older (more mature) firms. More importantly, our findings demonstrate an inverted U-shaped relationship between the level of tax incentives and their impact on ESG performance, with the optimal tax incentive level estimated at approximately 85%. Furthermore, we unveil the mechanisms through which tax incentives influence corporate ESG performance. The results suggest that tax incentives improve ESG performance through multiple channels, including promoting green innovation, strengthening internal controls, facilitating the adoption of financial technology, and enhancing the quality of environmental information disclosure. This study contributes to and expands upon recent research within the resource-based view, offering valuable insights for corporate tax practices in developing countries and tax authorities’ regulatory strategies.