Bunching Responses to Training Expenses Deduction Policy : Evidence from Kinks in China

This paper explores firms’ bunching responses to training expenses deduction policy using microdata on Chinese manufacturing firms from 2004 to 2007. By exploiting a bunching method, we estimate the elasticities of training intensity with respect to (one plus) the marginal tax rate at the kink points. We provide robust evidence that firms bunch at kink points and gradually respond to a threshold change. Taking policy compliance into account, the estimated elasticity of fiscal incentives is −0.716 and −0.504 for domestic-owned enterprises (DOEs) and foreign-owned enterprises (FOEs), respectively. Based on these estimates, we find that if all the training expenses are deductible, then the training intensity will increase by 23.6% (DOEs) and 7.5% (FOEs). Heterogeneous analyses indicate that the wage-ratio-based policy may spur more bunching incentives among firms with higher wage bills. Finally, we rule out alternative explanations of tax evasion, relabeling, and manipulation of wage bill