Do Tax Incentives Enhance Entrepreneurship? Evidence from Value‐Added Tax Reform in China

Abstract This paper investigates the causal effect of tax incentives on entrepreneurship. Using a staggered Value‐Added Tax (VAT) reform in China as an exogenous shock to conduct difference‐in‐differences estimation, we find that tax cuts have a considerable positive effect on local entrepreneurship. A plausible mechanism driving our findings is the ease of financial constraints. Our results are robust to a battery of endogeneity and robustness tests. We find that regions with high levels of institutional quality, trust, or a commercial culture undergo greater entrepreneurship after the VAT reform. Overall, this study provides a timely policy evaluation of the importance of tax incentives in promoting entrepreneurship in a typical emerging market.