This paper investigates the effects of the investment value-added tax credit reform in China in 2004 on firms’ innovation behaviors. The difference-in-difference-in-differences (DDD) estimation results show that the reform significantly increases firms’ capital expenditures on fixed assets; however it decreases R&D investment, resulting in lower innovation. More importantly, the results show that the negative impacts of the reform on innovation are stronger for financially more constrained firms, non-SOE firms, and solely domestically owned firms. These findings suggest that financial constraints may cause some unintended consequences of investment tax credits. 

JEL Classification: O31, O32, G31.
Keywords: Value-added tax reform; capital expenditure; innovation; financial constraints​