Do Tax Policies Drive Innovation by SMEs in China?

Journal of Small Business Management, 2020, Forthcoming

54 Pages Posted: 29 Jun 2017 Last revised: 18 Mar 2020

See all articles by Runhua Wang

Runhua Wang

Chicago-Kent College of Law

Jay P. Kesan

University of Illinois College of Law

Date Written: June 28, 2017


There is little empirical evidence showing how innovation by small and medium enterprises (SMEs) is impacted by tax policies, especially SMEs from developing countries. We study the economic rationales for R&D tax incentives and explore how targeted policies of corporate tax credits (firm-specific) and value-added tax credits (product-specific) in China impact the domestic SMEs’ R&D investment and R&D output. The “finance gap” theory can explain the R&D increase by SMEs induced by corporate tax credits but cannot explain the effectiveness or the ineffectiveness of value-added tax credits on R&D incentives. We find a stringent corporate tax policy with narrowly tailored R&D thresholds for tax credits can positively incentivize R&D and patent applications by SMEs. We also find that a value-added tax policy without any R&D thresholds is overinclusive in terms of its impact on the subsidized SMEs’ innovation. Value-added tax credits cannot induce R&D when they do not confer subsidies or a competitive advantage on SMEs. However, we find that the value-added tax policy creates a spillover effect on R&D by SMEs in other technology sectors who may choose to qualify for these value-added tax credits.

Keywords: Small and medium enterprise, Corporate tax credits, Value-added tax credits, Innovation

Suggested Citation

Wang, Runhua and Kesan, Jay P., Do Tax Policies Drive Innovation by SMEs in China? (June 28, 2017). Journal of Small Business Management, 2020, Forthcoming, Available at SSRN: or

Runhua Wang (Contact Author)

Chicago-Kent College of Law ( email )

565 W. Adams St.
Chicago, IL Illinois 60661
United States

Jay P. Kesan

University of Illinois College of Law ( email )

504 E. Pennsylvania Avenue
Champaign, IL 61820
United States
217-333-7887 (Phone)
217-244-1478 (Fax)


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