Corporate Tax Cuts for Small Firms: What Do Firms Do?

What do small firms do when given a semi-permanent corporate income tax cut? We examine firm responses to a substantial reduction in the tax rate for small- and micro-profit enterprises (SMPE) in China, using gradual increases in the qualifying threshold during 2010-2016 for identification. Based on confidential tax returns, we find that newly qualified SMPEs with immediate tax savings increased investment and productivity, while there was no change in wages or payout to shareholders. There is some weak evidence the tax cut induced entry of micro-sized firms in financially constrained sectors. Yet its size-based design led to bunching and incentivized firms to slow down growth when they approached the size threshold.