Personal income tax and corporate innovation: The key role of inventors’ financial incentives

Despite the importance of the personal income tax around the world, little is known about its impact on innovation. We construct a large database of inventors who patented at publicly listed companies during the 2008–2016 period and exploit the revised Personal Income Tax (PIT) Law of 2011 in China as a quasi-natural experiment to establish the causal effect of the personal income tax on corporate innovation. Using a difference-in-differences identification strategy, we show that a lower personal income tax rate has a significantly positive impact on patent quantity and quality. Further, the revised PIT Law raises the efficiency of R&D activities, induces more explorative innovation, and improves the success rate of patent applications, providing consistent evidence for the intentional effort channel. Moreover, this positive innovation effect is more pronounced in firms with an R&D team that is more sensitive to the salary incentive system, greater innovation dependence, better governance, and firms located in regions with better innovation environments. Taken together, our findings shed light on how inventors and firms respond to decreasing personal income tax rates and confirm that the net return to innovation can be vital to the innovation capacity of firms.