Do Regional Tax Incentives Distort the Spatial Distribution of Foreign Investment? Evidence From the 2008 Tax Reform in China

ABSTRACT Regional tax incentives lead to differences in investment profits across regions, which may distort the spatial distribution of FDI. This paper, based on the 2008 corporate income tax reform in China, investigates whether the repeal of the regional preferential tax policy for foreign invested enterprises (FIEs) adjusts and further improves FDI spatial distribution. Employing a difference‐in‐differences estimation method, we find that the repeal of the policy induces foreign investments, especially those sourced from countries with relatively higher income tax rates for firms, to shift from the initial “tax‐preferential regions” to the original “non‐tax‐preferential regions”. Nonetheless, sufficient industrial support and a well‐institutionalised business environment attenuate this effect. Specifically, strong upstream industrial supporting capacity restrains the outflow of midstream FDI and substantial downstream industrial support has a more significant impact on downstream FDI. We also confirm that regional tax incentives cause spatial distortions in the distribution of FDI, as evidenced by the significant increase in industrial linkages between FIEs and geographically proximate firms following the revocation of these incentives. This paper contributes to the literature on the impact of regional tax incentives on the spatial distribution of FDI and provides policy recommendations tailored to promoting regional coordinated development.