Tax incentives and within-firm pay inequality: the distributional effects of innovation incentives

Purpose Within-firm pay inequality has garnered extensive global attention, not merely because it influences the perception of fairness within firms, but also because it serves as a crucial driver of overall societal income inequality. Against the backdrop of innovation-driven development, governments have increasingly implemented tax incentive policies to boost firms’ innovation capabilities. However, a pressing question remains: do these tax incentives widen income disparities within firms, disproportionately benefiting top executives and thereby reinforcing the “Matthew effect”? Or do they foster overall innovation output, subsequently raising the incomes of regular employees and alleviating income inequality? Design/methodology/approach This study uses the 2015 R&D expense super deduction policy reform as a quasi-natural experiment to explore the impact of innovation tax incentives on within-firm income inequality. Using disclosure information from corporate annual reports, we precisely identify whether firms benefited from this policy. Specifically, firms that received the policy benefit are defined as the treatment group, while firms that did not are designated as the control group. To evaluate the impact of this policy on internal income inequality within firms, we employ the standard Difference-in-Differences (DiD) method for regression analysis. Findings The findings indicate innovation tax incentives significantly widen the income disparity within firms, particularly the wage gap between management and regular employees. Mechanism analysis reveals tax incentives increase corporate innovation output and business performance, which in turn exacerbates the imbalance in profit sharing, allowing management to gain higher incomes. Additionally, tax incentives enhance R&D investment and risk-taking levels, providing management with more risk-related incentives and compensation, thereby aggravating income disparity. The heterogeneity analysis shows the impact of innovation tax incentives on income disparity is more pronounced in firms with stronger bargaining power among regular employees, state-owned enterprises, and high-tech industries. Research limitations/implications This study not only enriches the literature on the factors influencing within-firm pay inequality and the distributional effects of innovation tax incentives but also provides empirical evidence for the government in advancing an innovation-driven development strategy and achieving the goal of common prosperity. Practical implications The results enrich the theoretical and empirical research on the effects of innovation tax incentives on internal income distribution. In terms of expanding the existing literature, this study not only examines the direct impact of innovation tax incentives on firms’ innovation input and output but also delves into the policy’s long-term effects on internal income distribution. Social implications This study offers an in-depth discussion and empirical examination of the impact of tax policies on income inequality at the firm level. The findings underscore the importance and correctness of the integrated use of tax reduction policies and income distribution policies, providing policymakers with robust evidence for simultaneously promoting innovation incentives and income fairness. Originality/value First, in terms of data and methodology, this study utilizes Python to automatically extract data on “R&D super deduction” accounts from firms’ annual reports, accurately identifying which firms truly benefited from the tax incentives. Second, in terms of expanding the existing literature, this study not only examines the direct impact of innovation tax incentives on firms’ innovation input and output but also delves into the policy’s long-term effects on internal income distribution. Third, this study offers an in-depth discussion and empirical examination of the impact of tax policies on income inequality at the firm level.