Local Carbon Falls, Neighbouring Pollution Rises: Truth About China’s Green Tax

China's environmental tax helped provinces with higher charges reduce carbon emissions, but some polluting companies may have moved to nearby regions where the rules were less strict. That is the central finding of the study 'Has the Environmental Protection Tax Contributed to China's 'Dual Carbon' Targets?' by Xinran Li and Tong Zhang, published in the journal Economies. The study examines whether a tax created to control pollution can help China stop the growth of carbon emissions before 2030 and achieve carbon neutrality before 2060.

When Pollution Fees Became a Climate Experiment

China replaced its pollution discharge fee with the Environmental Protection Tax on 1 January 2018, creating the country's first independent tax law built around the idea of a green taxation system. The policy follows the 'polluter pays' principle by making companies bear more of the social and environmental costs created by their emissions, encouraging them to use cleaner energy, improve production technology or reorganise carbon-intensive operations.

Carbon dioxide is not directly included among the pollutants taxed under the law, which mainly covers air pollution, water pollution, solid waste and noise. The researchers wanted to discover whether taxing these pollution sources could still produce an indirect carbon benefit, because fossil-fuel consumption often generates carbon dioxide and conventional pollutants at the same time.

The team treated the 2018 fee-to-tax reform as a quasi-natural experiment and examined 480 observations covering 30 Chinese provinces, municipalities and autonomous regions from 2007 to 2022. Provincial carbon emissions were calculated from fossil-fuel, electricity and heat consumption using official Chinese and Intergovernmental Panel on Climate Change emission factors.

Two outcomes were examined: carbon emissions per person and carbon-emission intensity, which measures emissions in relation to economic output. The models accounted for urbanisation, GDP per person, reliance on coal, industrial structure, research and development spending, international trade exposure, transport infrastructure, provincial characteristics and nationwide changes over time.

Stronger taxes produced deeper reductions inside provinces

The researchers compared provinces that raised their collection standards with those that largely carried the previous fee levels into the new tax system. They also compared provinces charging above the national median with those applying lower tax intensity.

Provinces that raised their tax standards recorded declines in both measurements. The estimated coefficients were −0.063 for per-capita emissions and −0.073 for carbon intensity. The effect was considerably stronger in provinces where tax intensity exceeded the national median, producing coefficients of −0.127 and −0.138 respectively, close to twice the reductions associated with merely increasing the former levy.

Businesses appear to make meaningful changes when taxation becomes strong enough to alter the financial calculation behind energy use, technology investment and production decisions. The authors describe this as an effective tax threshold: weak charges can be absorbed as another operating expense, while more substantial costs encourage companies to conserve energy, adopt cleaner technology or change their output structure.

Regional tests found stronger benefits where increases reflected a greater greening of the tax system, particularly for carbon intensity. Tests based on existing tax levels showed that areas with weaker green-tax foundations sometimes gained more from the reform because it introduced a genuinely new constraint. Provinces already using several well-developed green taxes had less room for one additional policy to create a large marginal improvement. Continually raising rates may deliver diminishing returns once taxation passes a certain level.

Confidence in the central finding was strengthened by pre-reform trend tests, which showed no significant difference between treatment and comparison groups before the policy began. Five hundred placebo simulations produced estimates concentrated near zero, suggesting that the measured reductions were unlikely to have been created by unrelated events or hidden provincial differences.

Carbon reductions crossed provincial borders in the wrong direction

A company facing rising environmental costs does not always clean up its operations. It may move production into a neighbouring province where taxes and enforcement are weaker. The researchers used spatial difference-in-differences models to capture this movement and found a troubling pattern described as 'local emission reductions and neighbouring increases.'

After geographical relationships were included, the local effects remained strongly negative. Raising the levy standard produced direct coefficients of −0.062 for per-capita emissions and −0.074 for carbon intensity. Above-median tax intensity produced even larger local effects of −0.125 and −0.137.

Higher taxation in one province was associated with increased emissions in neighbouring provinces, with positive coefficients ranging from 0.316 to 0.394. When the researchers separated direct and indirect effects, the neighbouring increase sometimes completely outweighed the local reduction, turning the estimated national effect positive for provinces that raised collection standards. Under the high-intensity measure, local gains and neighbouring losses largely cancelled each other out.

Why China's Green Tax Strategy Must Cross Provincial Boundaries

The study supports moderately raising tax rates where current charges remain below the real cost of pollution control, while rejecting a uniform nationwide increase that ignores local industrial structures, environmental pressures and existing green taxes. Tax authorities and environmental agencies also need stronger information-sharing systems so collection standards are consistently enforced.

The authors recommend expanding coverage beyond air, water, solid waste and noise to emerging concerns such as soil contamination and biological pollution. They also argue that carbon dioxide should become a formal taxable item, creating steady pressure for businesses to choose the most economical method of cutting emissions.

The study cannot clearly show whether emissions fell because of government tax spending or because companies changed their practices. Provincial data also cannot track exactly how businesses and emissions moved between regions. Firm-level evidence will be needed to track those mechanisms.