The impact of tax reform on firms' digitalization in China

Digital transformation is continuous and costly, thereby posing a challenge to the stability of firms' cash flow. Tax cuts are conducive to improving cash flow condition. This study examines the impact of the business tax to valueadded tax (BT to VAT) policy on digital transformation by using data of listed firms in China from 2007 to 2019. We measure the degree of firms' digitization by textual analysis and find that the BT to VAT policy significantly promotes the digital transformation of firms. Our results remain robust after several robustness checks. Heterogeneity analysis shows that the driving effects of the BT to VAT policy on digital transformation are considerably pronounced for high-tax-burden, low-profit, and non-state-owned firms; firms with high financing constraints; and firms located in the eastern region. Lastly, this study examines the potential mechanisms. Findings suggest that the tax cut effects of the BT to VAT policy enable firms to undertake digital transformation. We also find that digital transformation strengthens firms' competitive performance, thereby possibly further enhancing the willingness of enterprises to pursue digital transformation.