Can Environmental Policy Redirect Technical Change?

Pollution Taxes, R&D, and Clean Technology Development∗

James R. Brown† , Gustav Martinsson‡ and Christian Thomann§

January 22, 2018

Abstract

Firms respond to higher taxes on air pollution by increasing R&D and reducing
tangible assets-in-place. These effects are relatively stronger in high-pollution industries
and only appear after taxes are introduced, indicating a causal linkage. Pollution taxes
also lead to a significant increase in the country-level stock of pollution abatement
technologies, suggesting the firm-level shift to R&D has aggregate effects on clean
technology development. However, the increase in R&D is concentrated in profitable
firms and firms closer to the technological frontier. Taxing activities with high
environmental costs can “redirect” technical change, but there are heterogeneous effects
across different types of firms.

Keywords: Directed technical change, Environment, Investment policy, Innovation, Green

growth, Air pollution, Climate, Tax policy
JEL codes: G31, O13, O33, Q53

∗
We appreciate helpful comments we received from conference and seminar participants at the 2017
Shanghai Green Conference and Swedish House of Finance. We are particularly grateful to Philipp Krueger,
Harrison Hong, Anders Anderson, Arik Levinson, and Luisa Dressler for constructive feedback, and Mistra
Financial Systems and Jan Wallander and Tom Hedelius Foundation for research support.
†
Brown is at Iowa State University, Ivy College of Business, Department of Finance, 3331 Gerdin Business
Building, Ames, IA 50011-1350, phone: +15152944668, email: jrbrown@iastate.edu
‡
Martinsson is at KTH Royal Institute of Technology, ITM School, Department of Industrial Economics
and Management, and Swedish House of Finance (SHoF), Lindstedtsvagen 30, SE-10044, Stockholm, Sweden,
phone: +46(0)87906962, email: gustav.martinsson@indek.kth.se
§
Thomann is at Royal Institute of Technology (KTH) and Centre of Excellence for Science and Innovation
Studies (CESIS), Lindstedtsvagen 30, SE-100 44, Stockholm, Sweden, christian.thomann@indek.kth.se
1 Introduction

The nature of technological change plays a central role in determining how environmental

constraints and regulations impact human welfare and economic performance (e.g., Stokey

(1988), Aghion and Howitt (1998), Popp, Newell, and Jaffe (2010)). Building on this insight,

a prominent theoretical literature explores the growth and welfare implications of policies

that “redirect” technical change toward environmentally-friendly production technologies

(e.g., Acemoglu, Aghion, Bursztyn, and Hemous (2012)). A key idea from this work is that

policy action is likely necessary to encourage the development of “clean” technologies, due

in part to path dependence in technical change (e.g., Acemoglu (1998), Acemoglu (2002);

Acemoglu, Akcigit, Hanley, and Kerr (2016); Aghion, Dechezleprêtre, Hemous, Martin,

and Van Reenen (2016)). With the optimal set of policies, directed technical change has

the potential to mitigate climate change risks and other environmental disasters without

significantly slowing long-run economic growth.

An important and largely open empirical question concerns the effectiveness of

environmental policy at influencing the direction of technical change. Can environmental

policies change the way firms invest and influence the amount they spend developing new

technologies? This study provides novel evidence on the effects of one widely used policy

tool: taxes on air pollution. Specifically, we study how increasing taxes on the emission of

sulfur and nitrogen oxides (SOx and NOx ), two of the major air pollutants, affects firm-level

investment decisions. We find that firms with the dirtiest production technologies respond

to higher taxes on air pollution by shifting away from physical capital and toward research

and development (R&D). However, this shift toward the development of new technology is

primarily driven by profitable firms who do not need outside capital to fund higher rates

of R&D spending, indicating that financing considerations can influence the effectiveness of

environmental policy and extent of directed technical change.

Our tests focus on the differential effects that changes in taxes on SOx and NOx

emissions have across firms located in industries with different (ex ante) propensities to

pollute. This difference-in-differences methodology broadly follows the approach Rajan

1
and Zingales (1998) (and many others) have used to evaluate the causal linkages between

country-level characteristics and real outcomes. The main idea is that if pollution taxes

causally affect firm-level investment decisions, the response should be relatively stronger

among firms located in industries with dirtier production technologies (i.e., industries with

a higher natural propensity to pollute).

We start with OECD data on the level of taxation of SOx and NOx by country and year

(Botta and Kozluk (2014)). To measure cross-industry differences in pollution intensity,

we use data on the emission of SOx and NOx per unit of output in each four-digit SIC

manufacturing industry from Levinson (2009). Finally, we use cross-country data on firm

investment policy from the Compustat Global database. The final sample covers around

24,000 firm-year observations in 130 manufacturing industries from 18 countries over 22

years.

We find robust evidence that higher taxes on air pollution are associated with a significant

shift away from tangible assets-in-place and toward R&D. Notably, higher pollution taxes

are associated with differentially higher rates of R&D in more pollution-intensive industries,

a finding that persists after controlling for a host of firm-specific characteristics, other

non-tax environmental policies, and across different samples and time periods. Our preferred

estimates show that the gap in firm R&D-intensity between a high pollution industry like

Plastic materials (95th percentile in industry pollution intensity) and an industry with no

air pollution is 0.002-0.003 larger in a country with high taxes on SOx and NOx emissions

like Sweden (95th percentile in pollution taxes) compared to a country with zero taxes on

SOx and NOx emissions like Belgium. This differential effect of pollution taxes on firm-level

R&D investment is approximately 10% of the average R&D-intensity across firms in the high

pollution industries.1
1
A potential challenge in quantifying the effects of higher pollution taxes is firms relocating their production
activities in response to changes in tax rates. Jaffe, Peterson, and Stavins (1995) survey the large literature on
the pollution haven effects of environmental regulation and conclude that, although environmental regulation
can impose large costs on polluting industries, these costs do not appear to significantly affect patterns of
international trade. A key reason is that high-pollution industries are among the least geographically mobile
industries (Ederington, Levinson, and Minier (2005)). For example, the most polluting industry in our sample
is cement manufacturing (see Table 3), which is also particularly geographically immobile (see the discussion
in Syverson (2004)). Other support for this idea appears in Dechezleprêtre, Gennaioli, Martin, Muûls, and
Stoerk (2015) and Dechezleprêtre and Sato (2017), who find no evidence that firms move production as

2
 In sharp contrast to the evidence for R&D, higher taxes on air pollution are associated

with differentially lower rates of firm spending on fixed capital. The magnitude of the

negative differential effect is about 3% of the average level of fixed capital investment.

Firms thus appear to respond to higher taxes on pollution by both scaling down tangible

investments and increasing expenditures on new technology development. Supporting this

conclusion, we find that R&D as a share of total investment (R&D plus capital investment)

and firm ratios of intangible assets-to-net fixed assets are differentially higher for firms in

high-pollution industries when tax rates on pollution increase, while the stock of tangible

assets-in-place is significantly lower.

Our main tests exploit changes in country-year levels of SOx and NOx taxation. However,

we also study how firm investment policy responds to the initial introduction of taxes on air

pollution, an “event” which is arguably exogenous to the investment decisions of any given

firm. Extending our identification approach to these time-series “shocks”, we find strong

evidence that the introduction of pollution taxes is associated with a differential increase

in R&D in firms located in sectors with more pollution-intensive production technologies.

Moreover, the positive differential effect of the first introduction of a pollution tax appears

only in the years after the introduction of the tax, consistent with a causal linkage (e.g.,

Bertrand and Mullainathan (2003)). At a minimum, this evidence addresses the potential

concern that policymakers only impose higher taxes on old (dirty) production technologies

after firms have shifted toward the development of new technologies.

Next, we consider whether the positive differential effect on R&D investment from higher

pollution taxes changes with the amount of internal cash flow that firms generate. There

are several reasons why higher pollution taxes may have heterogeneous effects on investment

activity in different types of firms. In particular, there is evidence that investment in R&D

is sensitive to the level of internal finance a firm generates (e.g., Hall and Lerner (2010);

Brown, Martinsson, and Petersen (2012)), suggesting that more profitable firms may be
environmental regulations tighten, Martin, de Preux, and Wagner (2014a), who find no effect on plant exits
or employment losses in the UK manufacturing sector from introducing a carbon tax, and Martin, Muûls,
de Preux, and Wagner (2014b), who find that polluting firms do not report plans to relocate or close down
plants under the EU emissions trading system (see Martin, Muûls, and Wagner (2016) for a survey of these
studies).

3
better positioned to respond to higher pollution taxes by shifting from tangible assets to

investment in R&D.

We find that the positive differential R&D effect we document for the full sample is driven

entirely by the firms with high levels of internal finance. In contrast, there is a small negative

and statistically insignificant differential effect from higher pollution taxes among firms with

low cash flows or low dividends. These findings suggest that financing considerations can

influence the extent to which environmental policies encourage new innovation, and highlight

one reason why complementary policies may be needed to redirect technical change (e.g.,

Acemoglu, Akcigit, Hanley, and Kerr (2016)). Otherwise, introducing higher pollution taxes

can have important long-run implications for industry competition, as newer firms with less

internal financial resources may find it harder to compete with established profitable firms.2

We also consider whether a firm’s distance to the technological frontier affects its

responsiveness to higher pollution taxes. This test builds on the evidence in prior studies

showing that firms positioned closer to the technological frontier are the primary drivers of

new technological innovations (e.g., Acemoglu, Aghion, and Zilibotti (2006); Vandenbussche,

Aghion, and Meghir (2006)). Consistent with this work, we find that the positive association

between pollution taxes and R&D is concentrated in the sub-set of firms closest to the

technological frontier.

Finally, we provide some suggestive evidence that the firm shift to R&D leads to the

development of cleaner production technologies at the country level. Using information

on patents for new technologies related specifically to air pollution abatement, we find a

significant positive relation between country taxes on air pollution and the country’s stock

of pollution abatement technologies. Though only suggestive, this evidence implies that the

shift in firm-level investment spending we document has important aggregate effects on the

development of environmentally-friendly technologies.

Our study contributes to several literatures. First, we are among a small set of empirical
2
In this way, our evidence is broadly consistent with Ryan (2012), who provides evidence of higher entry
costs, and subsequently welfare losses, in the cement manufacturing industry following stricter environmental
regulation. Similarly, List, Millimet, Fredriksson, and McHone (2003) find evidence that new plant births
slow in pollution intensive industries in the wake of a tightening of environmental standards.

4
studies to evaluate how innovative activity responds to changes in environmentally-related

prices and policies. For example, Popp (2002) finds that higher prices lead to more innovation

in the energy sector, and Aghion, Dechezleprêtre, Hemous, Martin, and Van Reenen (2016)

find that higher fuel prices encourage clean technology innovations in auto companies.3 In a

related but distinct vein, we provide broad evidence that firm innovative activity responds

positively to increased tax rates on dirty production technologies. Moreover, we identify

important heterogeneities across different types of firms in the extent to which innovation

responds to the higher tax rates. We are not aware of any other studies that highlight the

importance of corporate financing capacity for understanding the effects and incidence of

environmental policies with the potential to redirect technical change.

Our work is also part of an emerging literature in financial economics on the impact

of climate change and other environmental issues on firms and financial markets. Hong,

Li, and Xu (forthcoming) find that financial markets under-react to climate change risks.

Dowell, Hart, and Yeung (2000) show that stricter environmental standards lead to higher

stock market values in a sample of US multinational corporations, while Krueger (2015) finds

that mandatory disclosure of greenhouse gas emissions on the London Stock Exchange has

a positive effect on the market value of the most affected firms. Our study is the first we

know of to directly link environmental policies with firm investment decisions.

Finally, our evidence is relevant for evaluating the macro-economic consequences of

environmental policies (e.g., Calel and Dechezleprêtre (2016); Dechezleprêtre and Sato

(2017); Albrizio, Kozluk, and Zipperer (2014); Jaffe, Peterson, and Stavins (1995); Jaffe

and Palmer (1997); Porter and van der Linde (1995)). Most importantly, our findings

suggest that the aggregate effects of environmental policy are likely multi-dimensional.

On the one hand, our findings show that taxing environmental pollutants can encourage

the development of new technologies, which is broadly consistent with a key theoretical

mechanism in the modern literature on endogenous growth under environmental constraints

(e.g., Acemoglu, Aghion, Bursztyn, and Hemous (2012); Acemoglu, Akcigit, Hanley, and

Kerr (2016)). But the heterogeneous effects we document across different types of firms
3
Also see Newell, Jaffe, and Stavins (1999).

5
suggest that policies seeking to redirect innovation by taxing existing (dirty) production

technologies may ultimately entrench established (profitable) incumbents, thereby altering

the competitive structure of industries.

2 Data, measurement, and sample characteristics

2.1 Sample construction

We build the firm-level sample from Compustat Global. The Compustat database reports

standardized financial statement information for publicly listed firms in a broad sample

of countries. We focus on non-U.S. firms with fully consolidated financial statements, a

primary industry classification in the manufacturing sector, and at least three non-missing

R&D observations over the period 1990 to 2012. We require countries to have at least

ten firms with usable R&D data since we need within-country, across-industry coverage of

R&D activity for our empirical tests. We drop firms from the United States because we

use information from the US to measure cross-industry differences in pollution-intensity, as

described below. We define all variables in Table 1.

We merge the firm-level data from Compustat with information on time-series changes in

air pollution taxes for 18 OECD countries. This results in a sample of approximately 24,000

firm-years across 18 OECD countries over the period 1990 to 2012. We collect information

on the level of taxes and charges directly applied to the pollution of sulfur oxides (SOx )

and nitrogen oxides (NOx ) from Botta and Kozluk (2014). The Botta and Kozluk (2014)

approach provides a categorical “score” for each country-year based on the extent to which

(SOx ) and (NOx ) emissions are taxed. The resulting pollution tax variable (Pollution taxes)

ranges between 0 and 6, with 0 indicating no pollution tax and larger values indicating higher

taxes on pollution. By construction, the categorical scores are comparable across countries

and over time.

Table 2 reports country-level averages for the pollution tax variable. There is considerable

variation across countries in Pollution taxes. Eight countries have zero Pollution taxes

throughout the sample period, while five countries have average values above 2 (column

6
(1)). There is also substantial within-country variation over time. Most countries do not tax

SOx and NOx pollution in 1990, but ten countries have such taxes by the end of the sample

period. Denmark, Korea, Norway, and Sweden have the largest increases in Pollution taxes

during the sample period. Column (3) reports the year a pollution tax is first introduced in

each country.

2.2 Industry pollution intensity

Our tests focus on the differential impact higher pollution taxes have on industries with

a higher natural propensity to emit air pollutants. To rank industries by how pollution

intensive their production technologies are (e.g., Albrizio, Kozluk, and Zipperer (2014);

Broner, Bustos, and Carvalho (2016)), we use information on industry emissions of sulfur

oxides (SOx ) and nitrogen oxides (NOx ) from Levinson (2009). We start with information

on pounds of SOx and NOx emitted per unit of output in each four-digit SIC industry in

the US in 1987. We then normalize these values between zero and one to construct an

index of industry pollution intensity (Pollution intensity). The intersection of the firm-level

Compustat data and information on industry-level pollution intensity leaves us with firms

in 130 four-digit SIC manufacturing industries.4

An important benefit of the pollution data from Levinson (2009) is the level of

disaggregation. Hettige, Martin, Singh, and Wheeler (1995) urge researchers to use the

most disaggregated data available when trying to measure industry pollution outputs.

The importance of disaggregation becomes clear if we were to focus on broader two-digit

SIC industry groupings. For example, Chemicals and allied products (SIC 28) includes

high-pollution industries like Plastics (SIC 2821) (Pollution intensity of 0.109, or more than

21 pounds of SOx and NOx per unit of output), as well as zero-pollution industries like Vitro

and in vivo diagnostics substances (SIC 2835).

We list the ten highest pollution industries in Panel A of Table 3. Hydraulic cement
4
We use pollution intensities from US industries because they are, to the best of our knowledge, the only
sufficiently disaggregated and comprehensive measures of cross-industry differences in the emission of major
air pollutants (e.g., Lucas, Wheeler, and Hettige (1992)). The evidence in Lucas, Wheeler, and Hettige (1992)
and Hettige, Lucas, and Wheeler (1992) suggests that cross-sector differences in pollution are stable across
countries and over time.

7
manufacturing (3241) is by far the industry with the highest pollution intensity. Panel B lists

ten of the zero-pollution industries. Industries contribute unevenly to the sample as is evident

in both Panel A and Panel B. Notably, high-pollution industries tend to have much lower

levels of R&D compared to non-polluting industries. Indeed, many of the zero-pollution

industries are the high-tech manufacturing sectors that are particularly R&D-intensive (e.g.,

six of the zero-pollution industries in Panel B are high-tech sectors based on the three-digit

SIC definition of high-tech in Brown, Fazzari, and Petersen (2009)). Intuitively, our tests

will explore whether the level of pollution taxation affects the magnitude of the gap in

R&D-intensity between firms in high- and low-pollution industries.

2.3 Firm characteristics in polluting and non-polluting industries

Table 4 reports sample averages for both the full sample of firms (column (1)) as well as

in the most (top 5%) and least (bottom 5%) pollution-intensive industries. Three facts

about differences between firms in polluting versus non-polluting industries are worth noting.

First, polluting firms are considerably less R&D-intensive (on average) than non-polluting

firms, and R&D therefore accounts for a much smaller fraction of total investment.5 Second,

polluting firms are larger, older, more capital-intensive, and have lower sales growth. Finally,

in line with polluting firms being more established, they also have higher levels of cash flow,

leverage, and dividends, and thus are less reliant on external equity finance. It is important

to note that while polluting firms are less R&D intensive than non-polluting firms on average,

their R&D is still economically meaningful. The average high polluting firm (top 5%) has

book value of total assets of around 5.5 billion USD, which implies that it spends around

140 million USD on R&D each year.

5
It is noteworthy that, unlike most other research that focuses on within-country differences across
industries, we sort on an industry characteristic (pollution intensity) which is inversely related the outcome
variable of interest (R&D intensity). It is thus much less likely that some demand-side factor will bias our
inferences.

8
3 Pollution taxes and R&D

3.1 Baseline specification

We evaluate the effects of pollution taxes with the following difference-in-differences

specification:

R&D i,t = β(Pollution taxes c,t−1 × Pollution intensity j ) + Xi,t + ηc,t + ηj + i,t (1)

where R&Di,t is the R&D-intensity of firm i in year t. Our main interest is the intersection

between the level of pollution taxes in country c at the beginning of each year (t-1 ) (Pollution

taxesc,t-1 ) and industry j ’s pollution intensity (Pollution intensityj ). In some specifications

we include Xi,t , which is a vector of firm-specific control variables, including Firm size, Firm

age, Sales growth, Sales, Cash flow, Cash holdings, Dividend, Debt, Stock issues, and lagged

R&D. All firm level control variables except firm size and age are scaled by the beginning of

the period book value of total assets. Specification (1) also includes both country-year fixed

effects (ηc,t ) and industry fixed effects (ηj ). The country-year fixed effects account for any

time varying country level factors that may impact R&D investment across all firms (such

as business cycle effects or the country’s institutional characteristics), and thus absorb the

uninteracted Pollution taxes variable. The industry fixed effects control for time-invariant

industry-specific characteristics, thereby absorbing the uninteracted Pollution intensity term.

If firms increase spending on the development of new technologies in response to higher

taxes on SOx and NOx emissions, then the logic of our identification strategy suggests that

R&D will increase most in the industries that are most affected by the change in pollution

tax rates – i.e., the industries with a relatively high ex ante pollution intensity. In this case, a

positive and economically meaningful estimate of β in specification (1) indicates that taxing

pollutants encourages firms to increase their innovative efforts. Note that such a finding is not

readily explained by omitted factors, as such factors would have to be positively correlated

with pollution tax rates yet differentially important for R&D in the least innovative industries

9
(see Table 3).6

3.2 Baseline results

Table 5 reports estimates of equation (1). We do not include country-year fixed effects in

columns (1)-(4) in order to explore the broad relation between Pollution taxes and firm

investment in R&D. In columns (1) and (2) we only include the country-year Pollution

taxes variable along with country, industry, and year fixed effects. Column (1) shows a very

small and statistically insignificant positive coefficient on Pollution taxes. When we control

for lagged R&D investment in column (2) the coefficient turns to zero. These results are

consistent with the fact that most industries – and particularly the more R&D-intensive

sectors – have a low pollution intensity, and thus are not affected by changes in pollution

tax rates. These results also alleviate any concerns one might have about the Pollution taxes

variable being somehow correlated with broad technological shocks or an economy’s overall

level of innovative activity.

We add the interaction term between Pollution taxes and Pollution intensity in columns

(3)-(6). The β coefficient reported in columns (3) and (4) is positive and highly statistically

significant, in line with our empirical prediction articulated above. The association between

the uninteracted Pollution taxes variable and R&D is virtually zero. This is strong evidence

that pollution taxes affect R&D only through the (differential) effect they have on firms

in high-pollution industries. It is noteworthy that the β coefficient varies considerably

moving from column (3) to (4) (from 0.028 to 0.006). The only difference between the two

specifications is that column (4) controls for lagged R&D (e.g., Hall (1992) and Himmelberg

and Petersen (1994)).

We include the country-year fixed effects in columns (5) and (6), which absorb the

uninteracted Pollution taxes term. The β coefficient is, if anything, slightly larger and

more precisely estimated when we control for country-year fixed effects.

In Table 6 we augment the baseline regression with various combinations of the firm
6
The challenge for alternative stories is even greater given that we find positive effects for R&D but
negative effects for fixed investment spending and the stock of tangible assets-in-place.

10
control variables contained in X. In each case, the estimated β coefficient is larger and more

precisely estimated compared to the estimate in Table 5. As in Table 5, the estimate on the

key interaction term is smaller when we include lagged R&D in the specification.

To evaluate the economic magnitude of the β coefficient, we compute a differential R&D

effect based on the difference in predicted R&D intensity across high- and low-pollution

industries in countries with high pollution tax rates compared to the corresponding difference

in countries with low rates. We report this “Economic effect” in the third from final row

of Table 5 and Table 6. The industry at the 95th percentile of pollution intensity is Plastic

materials (SIC 2821), and we compare R&D-intensity in this ‘high pollution’ industry with

R&D in a zero pollution industry such as In Vitro and in vivo diagnostics substances (SIC

2835).

The estimate of β in column (6) of Table 6 indicates that, on average, the difference in

R&D between firms in high- and low-pollution industries is 0.003 larger in a country at the

95th percentile in pollution taxes (Sweden) compared to country with low pollution taxes

(Belgium). For context, we report average R&D intensity for the firms in the top 5% polluting

industries in the next to last row. In the most conservative specification (column (6)), the

predicted R&D differential is just over 10% of average R&D among firms in the high-pollution

industries (Table 4). In the specifications with no control for lagged R&D, the economic

magnitude of the estimated effect is more than twice as large. We take this as evidence

that controlling for lagged R&D provides a lower-bound estimate on the responsiveness of

R&D to changes in pollution tax rates, so we include the lag term in all specifications going

forward.

3.3 Other environmental policies

One potential concern is that higher taxes on air pollution are part of a broader package

of environmental policies. In this case, although our findings would still show a link

between environment policy and technical change, the particular policy mechanisms would

be unclear. We therefore consider four additional environmental policies with the potential

to influence firm investment decisions: emission trading schemes using renewable energy

11
certificates (Trading), so called ‘feed-in-tariff’ schemes (Tariff ), emission limit standards

(Standard ), and government R&D subsidies of renewable energy (Clean R&D). As in the

main regressions, we interact each of these additional environmental policy measures with

industry Pollution intensity.

Columns (1) to (4) in Table 7 show that none of the additional interaction terms attract

a coefficient that is statistically different from zero. These results are reassuring for multiple

reasons. In particular, they show that there is not some hard-wired connection (perhaps

for spurious reasons) between country efforts to strengthen environmental regulation and

innovative activity in industries with dirty production technologies. In addition, there is

little or no theoretical reason to expect these alternative environmental policy variables to

be differentially important for high air pollution industries, as they more broadly target the

development of renewable/clean energy.

In columns (5) and (6) we include the four additional environmental policy interaction

terms together with the main Pollution taxes x Pollution intensity term. Whether or not

we include the vector of firm controls, we find a positive and significant coefficient on the

Pollution taxes x Pollution intensity interaction, consistent with our baseline results.

3.4 Alternative samples and approaches

Table 8 and Table 9 report several robustness checks on our main findings. First, we address

the fact that the number of firms across four-digit manufacturing industries is unevenly

distributed. In column (1) we drop the industries with fewer than 200 firm-years, while in

column (2) we drop the industries with more than 2000 firm-years. The main interaction

effect is unchanged when we drop large and small industries, showing that our results are

not unduly influenced by outlier industries. Second, we consider the stability of our baseline

results across time. Column (3) reports results using only the first 10-year period (1991-2001),

while column (4) reports results using the second period (2002-2012). The estimate of β is

very similar in each of the two sub-periods.

Third, we address the fact that countries contribute unevenly to the overall sample. In

column (5) we drop the countries that contribute fewer than 200 firms (Austria, Greece,

12
Ireland, Korea and Spain) and continue to find a positive differential effect on R&D. In

column (6) we drop the three countries in our sample that contribute more than 2000 firms

(Canada, Japan and the UK). Despite the sharp reduction in sample size, we continue to

find a positive and significant coefficient on the key interaction term.

Fourth, we drop industries (in column (7)) and countries (in column (8)) with zero in

Pollution intensity and Pollution taxes, respectively. We continue to estimate a positive and

significant differential effect when we omit all firms from industries with no pollution of SOx

and NOx . Similarly, our main result is unchanged when we remove the countries that never

impose a tax on SOx and NOx .

We provide results of additional robustness exercises in Table 9. The summary

statistics in Table 4 show several important differences between firms from polluting and

non-polluting industries. To confirm that the industry Pollution intensity measure is not

merely reflecting these differences, we interact country Pollution taxes with the full vector of

firm characteristics (X). Column (1) shows that the estimate on the main Pollution taxes x

Pollution intensity term remains positive and statistically significant when these additional

interaction terms are included in the regression.

In column (2) we interact Pollution taxes with a measure of each industry’s geographic

mobility from Ederington, Levinson, and Minier (2005).7 This approach addresses the

potential for pollution haven effects (e.g., Jaffe, Peterson, and Stavins (1995)), wherein

firms respond to an increase in pollution taxes by moving production to other areas, to bias

our inferences on the association between pollution taxes and firm innovative efforts. The

coefficient on the Pollution taxes x Pollution intensity interaction is larger in magnitude and

more precisely estimated when we control for an industry’s geographic immobility.

Columns (3) and (4) show that our findings are also robust to controlling for time-series

changes in the industry’s share of total R&D and total employment in the country. Finally,

in columns (5) and (6) we report the baseline result with two-way clustered standard errors.

Clustering by firm and country (column (5)) or industry and country (column (6)) has no
7
As emphasized in Ederington, Levinson, and Minier (2005), the most polluting industries are also the least
geographically mobile: the correlation between Pollution intensity and the measure of geographic immobility
is 0.65.

13
impact on our inferences.

3.5 Event analysis

In Table 10 we report estimates of equation (1) using the date an air pollution tax is first

introduced (see Table 2) instead of the continuous Pollution taxes variable. Specifically, we

create an indicator variable, Reform, which equals one in all years starting with the year the

pollution tax is first introduced, and zero otherwise. We then interact the Reform indicator

with industry Pollution intensity to test whether the implementation of a pollution tax

differentially affects R&D in high-pollution industries.

We start in Table 10 by excluding the country-year fixed effects and estimating the broad

relation between Reform and firm-level R&D investment. Column (1) shows that, consistent

with our inferences in Table 5, there is no overall correlation between the initial introduction

of a tax on air pollution and firm investments in R&D. However, columns (2)-(4) show that

the Reform x Pollution intensity interaction attracts a positive and statistically significant

coefficient, indicating that the introduction of a tax on SOx and NOx emissions is associated

with a differential increase in R&D in industries with higher Pollution intensity.

In column (4) we address potential concerns about reverse causality by evaluating whether

the effects of the introduction of pollution taxes show up before the actual event. Clearly,

if our findings are causal, we should not find evidence that pollution taxation impacts

R&D differentials prior to the initial introduction year. We test this idea by including

an interaction between industry Pollution intensity and a dummy variable equal to one in

the year before the pollution tax is introduced (Before). The results in column (4) show

that the Before x Pollution intensity interaction attracts a small and insignificant coefficient

estimate, suggesting that reverse causality is not driving our results. At the same time,

the coefficient on the Reform x Pollution intensity interaction remains positive, statistically

significant, and large in magnitude, indicating that the positive association between pollution

taxes and R&D is only present in the years following the initial introduction event.

14
4 Heterogenous effects across types of investment and firms

4.1 Pollution taxes and tangible assets

In this section we evaluate how pollution taxes impact firm investment in fixed assets. We

do this for multiple reasons. First, to the extent that higher pollution taxes have a different

effect on fixed investments than on R&D it suggests that the environmental policy shapes the

direction of technical change. Second, there is no clear theoretical reason for higher higher

pollution taxes to increase a firm’s tangible assets-in-place, so evidence of differences across

the different types of firm activities is strong support for the mechanism we have emphasized.

Finally, our findings on how pollution taxes affect R&D investment should also apply more

broadly to the firm’s stock of intangible assets.8

Column (1) of Table 11 reports results from estimating Specification (1) with Fixed

investment as the dependent variable. There is a negative and statistically significant

coefficient on the Pollution taxes x Pollution intensity interaction, showing that higher

pollution taxes are associated with relatively less fixed investment in high-pollution

industries. The “Economic effect” reported in the third to final row of Table 11 is -0.002.

Average Fixed investment of polluting firms is higher than the average level of R&D (0.055

compared to 0.026), which means the economic magnitude is smaller for fixed investment

than for R&D (e.g., the positive R&D differential following higher pollution taxes presented

in the final column of Table 6 is approximately 10% of average R&D, whereas the negative

fixed investment differential is about 3% of the mean).

In column (2) we estimate equation (1) with the stock of Fixed assets as the dependent

variable. The estimate on the key interaction term is negative and statistically significant,

indicating that tangible assets-in-place decline following an increase in taxes on the emission

of air pollutants.

The results in columns (3) and (4) use R&D as a share of total investment
8
In contrast to R&D, which is a flow of new intangible investment spending, the stock of intangible assets
is taken from the balance sheet and includes items like patents and copyrights. This broader measure of
intangible activity is also attractive because it would include intangible assets acquired from other firms. Our
measure of intangible assets follows Claessens and Laeven (2003).

15
(R&D/investment) and the ratio of intangible assets-to-net fixed assets (Intangible assets)

as the dependent variables. The estimates show that both measures are differentially higher

in high-pollution industries when pollution taxes increase. These results are consistent with

pollution taxes inducing a shift to intangible activity and away from tangible assets.

4.2 Internal finance

The intangible and uncertain nature of R&D likely makes it more challenging for firms

to fund new innovative investment with external finance (e.g., Hall and Lerner (2010)). We

therefore consider whether a firm’s financial position influences how it responds to an increase

in pollution tax rates by sorting firms into two groups based on the amount of Cash flow or

Dividend they generate over the sample period. For each variable, firms above the sample

median should be better positioned to respond to higher pollution taxes by increasing their

innovative efforts.9

Table 12 reports estimates of Specification (1) for the different sub-samples of firms

with high and low internal finance. Column (1) shows a positive R&D differential for firms

with high Cash flow, consistent with our estimates for the full sample. In sharp contrast,

column (2) shows a negative and insignificant coefficient on the key interaction term for the

sub-sample of firms with low Cash flow. We find similar results if we short firms by high and

low dividends (columns (3) and (4)). These results show that our overall findings on the link

between pollution taxes and R&D are entirely driven by the more profitable firms.10
9
Firms in high-pollution industries are more profitable than other firms (as reported in Table 4), but there
is still a sizable fraction of firms from these sectors that end up in the sub-sample of low internal finance
firms. For example, among firms in the most pollution-intensive industries (top 5%), around 40% (43%) are
in the low cash flow (dividend) sub-samples.
10
It is possible that low internal finance firms are systematically younger and thus already have a cleaner
production technology. In this case, young firms with low cash flows would have less incentive to shift to
R&D in response to higher environmental taxes. In unreported regressions, we find that young and mature
firms have a very similar response to higher pollution taxes. In addition, there are no important differences
across young and mature firms within internal finance sub-samples: both young and mature firms with high
internal finance increase R&D when pollution taxes increase.

16
4.3 Distance to the technological frontier

An important literature emphasizes how a firm’s proximity to the technological frontier

influences the nature and impact of their innovative efforts. Namely, firms closer to the

technological frontier are more likely to drive the discovery and adoption of new technologies,

whereas firms further from the frontier are more likely to use existing technology and imitate

the innovation of others (e.g., Acemoglu, Aghion, and Zilibotti (2006) and Vandenbussche,

Aghion, and Meghir (2006)). In this way, if our findings reflect an important shift toward new

innovations, we expect a stronger response among firms close to the technological frontier.

We follow previous work and define distance to the technological frontier by taking the

ratio between a firm’s R&D intensity and the maximum R&D intensity in the industry, which

means that the firm defining the frontier has a value of one. We consider firms above (below)

the median in this relative R&D intensity measure to be close to (far from) the technological

frontier.

We present results for firms closest to the technological frontier in columns (1) and (2)

of Table 13, and results for firms farthest from the frontier in columns (3) and (4). Using

Pollution taxes in odd numbered columns and the Reform event in even numbered columns,

the estimates show that the positive differential R&D effect from higher pollution taxes

is driven by firms closer to the technological frontier. There is no R&D response in the

firms further away from the frontier, consistent with these firms not being major drivers of

technical change.11

5 Pollution taxes and new innovations in clean technology

Our main findings show a shift toward innovative investment when polluting firms face higher

taxes on SOx and NOx emissions. We now consider whether these higher tax rates also lead to

more innovations in clean technology. Specifically, we test the aggregate relationship between
11
In a related vein, Albrizio, Kozluk, and Zipperer (2014) find that stricter environmental regulation is less
damaging for productivity growth in more technologically advanced firms.

17
Pollution Taxesc,t-1 and the level of patenting in air pollution abatement technologies.12

The specification is:

Patents c,t = β(Pollution Taxes c,t−1 ) + Xc,t + ηc + ηt + c,t (2)

where Patentsc,t is either the stock of all patents (All patents) or triadic patents (Triadic

patents) classified in air pollution abatement technologies by country c in year t. We

include Xc,t , which is a vector of time-varying country control variables, including ln(GDP

per capita), ln(GDP), and the lagged dependent variable. Specification (2) also includes

country fixed effects (ηc ) and year fixed effects (ηt ). We present the results from estimating

Specification (2) in Table 14.

Columns (1) and (2) report results for all patents in air pollution abatement technologies.

We find a positive and significant relation between country-level pollution tax rates and

subsequent innovations specifically related to air pollution abatement. However, it is well

known that not all patents represent actual invention (e.g., Moser, Ohmstedt, and Rhode

(Forthcoming)). We therefore consider the stock of Triadic patents, which are the patents

that have been patented in the three main patent offices: USPTO, EPO and JPO. Triadic

patents cover only the most valuable inventions, so there is less concern that the measure

captures strategic patenting rather than new innovation (see Aghion, Dechezleprêtre,

Hemous, Martin, and Van Reenen (2016) for a discussion). We report the results using

Triadic patents in columns (3) and (4). The positive association between pollution tax rates

and patents in pollution abatement technologies is more precisely estimated when we focus

only on Triadic patents.

Though only suggestive, these results are consistent with the firm-level shift in investment
12
We follow the OECD’s patent strategies for identification of environment-related technologies
(ENV-TECH). The OECD divides air pollution abatement patents into emission abatement from stationary
and mobile sources, and one residual category of air pollution abatement patents not being classified as
either stationary or mobile sources. Within each of these classes they sub-divide into post-combustion and
integrated technologies. Examples of IPC classes are Manufacture of carbon steel, e.g. plain mild steel, medium
carbon steel, or cast-steel; Removal of waste gases or dust (C21C5/38), classified as emissions abatement from
stationary sources and integrated technologies, or Filters or filtering processes specially modified for separating
dispersed particles from gases or vapors (B01D46) classified in the residual category and post-combustion
technologies. The full list of air pollution abatement technologies can be found in OECD’s data portal:
https://stats.oecd.org under Patents – Technology development.

18
spending that we document having important aggregate consequences for the development

of environmentally-friendly technologies.

6 Conclusions

We study how a country’s level of pollution taxation affects firm investments in R&D and

tangible capital. We find that higher pollution taxes lead to a substantial shift from spending

on tangible fixed assets to investment in R&D. Pollution taxes have relatively stronger effects

in sectors with dirtier (ex ante) production technologies. The level of pollution taxes lead to

higher R&D investment only in firms that have high levels of internal financial resources and

are relatively closer to the technological frontier. Our findings show that while environmental

policies can affect the direction of technical change, these policies likely have heterogeneous

effects across different types of firms.

19
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 Table 1: Description of variables

Variable name Definition Source

R&D Firm level research and development (R&D) Compustat Global
expenditures scaled by the beginning of the year
book value of total assets and Winsorized at the 1%
level.

Fixed investment Firm level fixed capital expenditures scaled by the Compustat Global
beginning of the year book value of total assets and
Winsorized at the 1% level.

Fixed assets Firm level book value of plant, property and Compustat Global
equipment scaled by the beginning of the year book
value of total assets and Winsorized at the 1% level.

R&D/investment Firm level research and development (R&D) Compustat Global

expenditures divided by total investment and
Winsorized at the 1% level. Total investment is
the sum of R&D expenditures and fixed capital
expenditures.

Intangible assets Firm level intangible assets scaled by the book value Compustat Global
of net fixed assets and Winsorized at the 1% level.

Firm size Firm size is measured as the natural logarithm of firm Compustat Global
level book value of total assets and Winsorized at the
1% level.

Firm age Firm age is measured as the natural logarithm of firm Compustat Global
age and Winsorized at the 1% level. Age is the number
of years since first sales observation in Compustat.
Firm-year observations are Winsorized at the 1% level.

Sales growth Annual log change in firm level sales and Winsorized Compustat Global
at the 1% level.

Sales Firm level sales scaled by the beginning of the year Compustat Global
book value of total assets and Winsorized at the 1%
level.
(Continue next page)

25
Cash flow Firm level cash flow scaled by the beginning of the Compustat Global
year book value of total assets and Winsorized at the
1% level.

Cash holdings Firm level cash holdings scaled by the beginning of the Compustat Global
year book value of total assets and Winsorized at the
1% level.

Dividend Firm level dividends scaled by the beginning of the Compustat Global
year book value of total assets and Winsorized at the
1% level.

Debt Firm level total debt scaled by the beginning of the Compustat Global
year book value of total assets and Winsorized at the
1% level.

Stock issues Firm level stock issues scaled by the beginning of Compustat Global
the year book value of total assets and Winsorized
at the 1% level. Stock issues is defined as the
annual difference between stocks issued and stocks
repurchased.

Pollution intensity Pounds of sulfur oxides (SOx ) and nitrogen oxides Levinson (2009)
(NOx ) per unit of output in each four digit SIC
industry in the US manufacturing sector in 1987.
Normalized between 0-1.

Pollution taxes Abbreviation for Pollution taxes. Taxes and charges Botta and Kozluk
directly applied to the pollution of sulfur oxides (SOx ) (2014)
and nitrogen oxides (NOx ). It is based on the tax rate
in Euros per tonne pollution by country and year.
Categorized between 0 to 6 indicating low to high
taxation level.

Trading Emissions trading schemes for CO2 and renewable Botta and Kozluk
energy certificates. Categorized between 0 to 6 (2014)
indicating low to high taxation level.

Tariff Subsidies for environmentally-friendly activities. Botta and Kozluk

Categorized between 0 to 6 indicating low to high (2014)
taxation level.
(Continue next page)

26
Standard Emission limit values of SOx , NOx and particulate Botta and Kozluk
matter (PM) in mg/m3 . Categorized between 0 to (2014)
6 indicating low to high taxation level.

Clean R&D Government R&D expenditures for renewable energy Botta and Kozluk
technologies (expressed as % of GDP). Categorized (2014)
between 0 to 6 indicating low to high taxation level.

Reform Reform is an indicator variable taking on the value Botta and Kozluk
one (zero) in the year a country first introduces the (2014)
pollution tax and afterwards (see Table 2 for the dates
of each country’s introduction) (otherwise).

All patents All patents is the natural logarithm of the stock of all Hascic and Migotto
patents (measured at the priority date) in air pollution (2015) and OECD
abatement technologies.

Triadic patents Triadic patents is the natural logarithm of the stock of Hascic and Migotto
patents (measured at the priority date) in air pollution (2015) and OECD
abatement technologies where the patent family size is
three or greater.

27
Table 2: Country level rates of pollution taxes
Table 2 reports the average values of Pollution taxes (in column 1) and the difference between 1990-2012 in
Pollution taxes (column 4) across the 18 countries in our sample. Table 1 provides detailed variable definitions.

Pollution taxes:
Average Difference Year of
1990-2012 1990-2012 Introduction
Australia 1.30 1.50 1998
Austria 0.00 0.00 No
Belgium 0.00 0.00 No
Canada 0.97 1.00 1992
Denmark 2.92 6.00 1998
Finland 0.00 0.00 No
France 1.10 2.50 1999
Germany 0.00 0.00 No
Greece 0.00 0.00 No
Ireland 0.00 0.00 No
Italy 2.28 2.50 1997
Japan 3.00 0.00 <1990
Korea 2.39 3.00 2001
Netherlands 0.00 0.00 No
Norway 1.14 3.00 2007
Spain 1.59 2.00 1996
Sweden 2.93 3.00 1992
United Kingdom 0.00 0.00 No

Mean 1.09 1.36 –

Median 1.04 0.50 –
Standard dev. 1.17 1.70 –

28
 Table 3: Pollution intensity and R&D investment in selected industries
Table 3 lists the 10 most (panel A) and 10 of the non-polluting (panel B) industries based on Pollution
intensity. lbs per output measures the total amount of pollution (in terms of pounds) of SOx and NOx per
unit of output in the US based on data from Levinson (2009). Table 1 provides detailed variable definitions.

Pollution lbs per #

SIC Industry R&D
intensity output obs.
Panel A: 10 most polluting industries
3241 Cement, Hydraulic 1.000 201.377 0.005 106
2611 Pulp mills 0.409 82.416 0.000 4
3334 Primary production of aluminum 0.272 54.693 0.010 46
3312 Steel works, Blast furnaces and Rolling mills 0.201 40.572 0.006 457
2621 Paper mills 0.196 39.424 0.006 248
3612 Power, Distribution, and Specialty transformers 0.145 29.242 0.038 203
2631 Paperboard mills 0.120 24.242 0.001 32
2821 Plastic materials, synth. resins and nonvulc. elast. 0.109 21.945 0.032 346
2911 Petroleum refining 0.099 19.949 0.007 327
3341 Secondary smelting and refining of nonf. metals 0.096 19.323 0.006 34
Panel B: 10 least polluting industries
2273 Carpets and Rugs 0.000 0.000 0.017 17
2835 In vitro and in vivo diagnostics substances 0.000 0.000 0.212 394
3572 Computer storage decives 0.000 0.000 0.057 87
3678 Electronic connectors 0.000 0.000 0.044 108
3663 Radio and tv broadcasting and comm. equipment 0.000 0.000 0.111 862
3821 Laboratory apparatus and furniture 0.000 0.000 0.049 49
2452 Prefabricated wood buildings and components 0.000 0.000 0.010 34
3451 Screw machine products 0.000 0.000 0.009 18
3843 Dental equipment and supplies 0.000 0.000 0.066 69
3944 Games, Toys, and Children’s Vehicles 0.000 0.000 0.049 243

29
Table 4: Polluting vs. non polluting firms
Table 4 reports firm mean in the key variables included in this study in column (1). Columns (2) and (3) report
firm means across the top 5% and bottom 5% of industries in Pollution intensity respectively. Column (4) report the
difference in means between columns (2) and (3). Table 1 provides detailed variable definitions. a , b , and c stand for
significance at the 1%, 5%, and 10% levels.

Bottom
Top 5%
5%
Sample polluting Difference
polluting
industries
industries
R&D 0.081 0.026 0.153 –0.127a

Fixed investment 0.048 0.053 0.045 0.008a

Fixed assets 0.254 0.368 0.172 0.196a

R&D/investment 0.508 0.275 0.685 –0.410a

Intangible assets 1.613 0.424 2.909 –2.485a

Firm size 5.564 7.104 4.298 2.806a

Firm age 2.155 2.290 1.999 0.291a

Sales growth 0.053 0.026 0.088 –0.062a

Sales 0.932 0.986 0.782 0.204a

Cash flow –0.016 0.055 –0.127 0.182a

Cash holdings 0.234 0.123 0.352 –0.229a

Dividend 0.010 0.011 0.008 0.003

Debt 0.210 0.258 0.174 0.084a

Stock issues 0.220 0.061 0.399 –0.338a

30
Table 5: Pollution taxes, pollution intensity and R&D investment
Table 5 reports OLS estimates of equation (1) with R&D as the dependent variable. All regressions include four digit
SIC level industry fixed effects. Columns (1)-(4) include fixed effects for country and year and columns (5)-(6) include
country-year fixed effects. Table 1 provides detailed variable definitions. Economic effect measures the difference in
either R&D in an industry at the 95th percentile of Pollution intensity relative to an industry at the 5th percentile in
a country at the 95th percentile of Pollution taxes versus a county at the 5th percentile. Mean top 5% represents the
mean value of the dependent for firms located in the top 5% polluting industries. The standard errors are clustered at
the country level. a , b , and c stand for significance at the 1%, 5%, and 10% levels.

(1) (2) (3) (4) (5) (6)

Pollution taxesc,t-1 0.004 0.001 0.003 0.000 – –
(0.005) (0.001) (0.004) (0.001)

R&Di,t-1 – 0.722 – 0.722 – 0.725

a a
(0.013) (0.013) (0.014)a

Pollution taxesc,t-1 x – – 0.028 0.006 0.029 0.007

Pollution intensityj (0.009) (0.002) (0.007) (0.002)a
a b a

Country fixed effects Yes Yes Yes Yes No No

Year fixed effects Yes Yes Yes Yes No No
Industry fixed effects Yes Yes Yes Yes Yes Yes
Country-year effects No No No No Yes Yes

Economic effect 0.009 0.002 0.009 0.002

Mean top 5% 0.026 0.026 0.026 0.026
Observations 24,133 21,280 24,133 21,280 24,133 21,280

31
Table 6: Pollution taxes, pollution intensity and R&D investment:
Different firm characteristics
Table 6 reports OLS estimates of equation (1) with R&D as the dependent variable. All regressions include four digit
SIC level industry fixed effects and country-year fixed effects. Table 1 provides detailed variable definitions. Economic
effect measures the difference in either R&D in an industry at the 95th percentile of Pollution intensity relative to an
industry at the 5th percentile in a country at the 95th percentile of Pollution taxes versus a county at the 5th percentile.
Mean top 5% represents the mean value of the dependent for firms located in the top 5% polluting industries. The
standard errors are clustered at the country level. a , b , and c stand for significance at the 1%, 5%, and 10% levels.

(1) (2) (3) (4) (5) (6)

Pollution taxesc,t-1 x 0.017 0.028 0.021 0.017 0.020 0.008
Pollution intensityj (0.007) (0.006) (0.005) (0.006) (0.004) (0.001)a
b a a b a

Firm sizei,t –0.013 – – –0.012 0.000 0.000

b b
(0.005) (0.005) (0.002) (0.000)

Firm agei,t –0.014 – – –0.007 0.004 0.009

(0.008) (0.005) (0.002) (0.004)b

Sales growthi,t – 0.029 – 0.029 0.012 0.004

(0.007)a (0.006)a (0.004)b (0.004)

Salesi,t – –0.012 – –0.013 0.027 0.022

c
(0.006) (0.006) (0.003) (0.005)a
b a

Cash flowi,t – – –0.234 – –0.234 –0.129

a
(0.010) (0.009)a (0.012)a

Cash holdingsi,t – – 0.129 – 0.119 0.066

a
(0.010) (0.009) (0.012)a
a

Dividendi,t – – 0.328 – 0.176 0.192

b
(0.114) (0.116) (0.055)a

Debti,t – – 0.001 – –0.013 0.002

(0.007) (0.008) (0.004)

Stock issuesi,t – – 0.001 – 0.003 0.005

(0.000)a (0.001)b (0.003)c

R&Di,t-1 – – – – – 0.575
(0.028)a

Industry fixed effects Yes Yes Yes Yes Yes Yes

Country-year effects Yes Yes Yes Yes Yes Yes

Economic effect 0.005 0.009 0.007 0.005 0.006 0.003

Mean top 5% 0.026 0.026 0.026 0.026 0.026 0.026
Observations 24,127
32
23,524 24,125 23,519 23,512 20,812
Table 7: Pollution taxes, pollution intensity and R&D investment: Other
environmental policies
Table 7 reports OLS estimates of equation (1) with R&D as the dependent variable. All regressions include four digit
SIC level industry fixed effects and country-year fixed effects. Column (6) includes the following firm control variables:
lagged R&D, Firm size, Firm age, Sales growth, Sales, Cash flow, Cash holdings, Dividend, Debt and Stock issues.
Table 1 provides detailed variable definitions. The standard errors are clustered at the country level. a , b , and c stand
for significance at the 1%, 5%, and 10% levels.

(1) (2) (3) (4) (5) (6)

Tradingc,t-1 x –0.015 – – – –0.017 –0.002
Pollution intensityj (0.014) (0.015) (0.003)

Tariffc,t-1 x – –0.005 – – 0.006 0.001

Pollution intensityj (0.005) (0.007) (0.002)

Standardc,t-1 x – – –0.002 – 0.003 –0.003

Pollution intensityj (0.008) (0.014) (0.003)

Clean R&Dc,t-1 x – – – –0.001 –0.013 –0.005

Pollution intensityj (0.009) (0.007)c (0.003)c

Pollution taxesc,t-1 x – – – – 0.034 0.009

Pollution intensityj (0.010) (0.002)a
a

Firm controls No No No No No Yes

Industry fixed effects Yes Yes Yes Yes Yes Yes
Country-year effects Yes Yes Yes Yes Yes Yes
Observations 24,133 24,133 24,133 24,133 24,133 20,812

33
Table 8: Pollution taxes, pollution intensity and R&D investment:
Robustness checks
Table 8 reports OLS estimates of equation (1) with R&D as the dependent variable. All regressions include four digit
SIC level industry fixed effects and country-year fixed effects and the following firm control variables: lagged R&D,
Firm size, Firm age, Sales growth, Sales, Cash flow, Cash holdings, Dividend, Debt and Stock issues. Table 1 provides
detailed variable definitions. Economic effect measures the difference in R&D in an industry at the 95th percentile of
Pollution intensity relative to an industry at the 5th percentile in a country at the 95th percentile of Pollution taxes
versus a county at the 5th percentile. Mean top 5% represents the mean value of the dependent for firms located in the
top 5% polluting industries. The standard errors are clustered at the country level. a , b , and c stand for significance
at the 1%, 5%, and 10% levels.

(1) (2) (3) (4) (5) (6) (7) (8)

Drop Drop Drop Drop Drop Drop
small large 1991-2001 2002-2012 small large zero-pol. zero tax
industries industries countries countries ind. countries

Pollution taxesc,t-1 x 0.008 0.006 0.009 0.009 0.008 0.005 0.005 0.007
Pollution intensityj (0.001) (0.001) (0.002) (0.002) (0.002) (0.002) (0.001) (0.003)b
a a a a a a a

Firm controls Yes Yes Yes Yes Yes Yes Yes Yes
Industry fixed effects Yes Yes Yes Yes Yes Yes Yes Yes
Country-year effects Yes Yes Yes Yes Yes Yes Yes Yes

Economic effect 0.003 0.002 0.003 0.003 0.003 0.002 0.002 0.002
Mean top 5% 0.026 0.026 0.026 0.026 0.026 0.026 0.026 0.026
Observations 16,977 16,466 5,674 15,138 20,257 5,993 15,710 16,017

34
Table 9: Pollution taxes, pollution intensity and R&D investment:
Alternative specifications
Table 9 reports OLS estimates of equation (1) with R&D as the dependent variable. All regressions include four digit
SIC level industry fixed effects and country-year fixed effects and the following firm control variables: lagged R&D,
Firm size, Firm age, Sales growth, Sales, Cash flow, Cash holdings, Dividend, Debt and Stock issues. Column (1)
include interactions between each firm control variable and Pollution taxes. Column (2) include an interaction term
between a measure each industry’s geographical immobility and Pollution taxes. Column (3) include industry share
in total country R&D. Column (4) include industry share in total country employment. Columns (5) and (6) twoway
cluster the standard errors by firm and country and industry and country respectively. Table 1 provides detailed
variable definitions. Economic effect measures the difference in R&D in an industry at the 95th percentile of Pollution
intensity relative to an industry at the 5th percentile in a country at the 95th percentile of Pollution taxes versus a
county at the 5th percentile. Mean top 5% represents the mean value of the dependent for firms located in the top 5%
polluting industries. The standard errors are clustered at the country level. a , b , and c stand for significance at the
1%, 5%, and 10% levels.

(1) (2) (3) (4) (5) (6)

Industry Industry
Firm controls Industry Twoway Twoway
Immobility x share
x Pol. Taxes share R&D cluster: firm cluster: ind.
Pol. Taxes Employment

Pollution taxesc,t-1 x 0.005 0.008 0.007 0.006 0.008 0.008

Pollution intensityj (0.001)a (0.002)a (0.001)a (0.001)a (0.001)a (0.003)a

Firm controls Yes Yes Yes Yes Yes Yes

Industry fixed effects Yes Yes Yes Yes Yes Yes
Country-year effects Yes Yes Yes Yes Yes Yes

Economic effect 0.002 0.003 0.002 0.002 0.002 0.002

Mean top 5% 0.026 0.026 0.026 0.026 0.026 0.026
Observations 20,812 20,812 20,812 18,392 20,812 20,812

35
Table 10: Pollution taxes, pollution intensity and R&D investment: The
introduction of the tax
Table 10 reports OLS estimates of equation (1) with R&D as the dependent variable. All regressions include four digit
SIC level industry fixed effects and country-year fixed effects and the following firm control variables: lagged R&D,
Firm size, Firm age, Sales growth, Sales, Cash flow, Cash holdings, Dividend, Debt and Stock issues. Reform is an
indicator variable taking on the value one (zero) in the year a country first introduces the pollution tax and afterwards
(see Table 2 for the dates of each country’s introduction) (otherwise). Before is an indicator variable taking on the
value one (zero) in the year before a country first introduces the pollution tax. Table 1 provides detailed variable
definitions. Economic effect measures the difference in R&D in an industry at the 95th percentile of Pollution intensity
relative to an industry at the 5th percentile in a country at the 95th percentile of Pollution taxes versus a county at
the 5th percentile. Mean top 5% represents the mean value of the dependent for firms located in the top 5% polluting
industries. The standard errors are clustered at the country level. a , b , and c stand for significance at the 1%, 5%, and
10% levels.

(1) (2) (3) (4)

Reformc,t x –0.002 –0.003 – –
(0.005) (0.005)

Reformc,t x – 0.018 0.020 0.020

Pollution intensityj (0.005)a (0.005)a (0.005)a

Beforec,t x – – – 0.002
Pollution intensityj (0.024)

Firm controls Yes Yes Yes Yes

Country fixed effects Yes Yes No No
Year fixed effects Yes Yes No No
Industry fixed effects Yes Yes Yes Yes
Country-year effects No No Yes Yes

Economic effect 0.002 0.002 0.002

Mean top 5% 0.026 0.026 0.026
Observations 20,812 20,812 20,812 20,812

36
Table 11: Pollution taxes, pollution intensity and investment policy
Table 11 reports OLS estimates of equation (1) with Fixed investment as the dependent variable in column (1),
Fixed assets in column (2), R&D/investment in column (3), and Intangible assets in column (4). All regressions
include four digit SIC level industry fixed effects and country-year fixed effects and the following firm control variables:
lagged dependent variable, Firm size, Firm age, Sales growth, Sales, Cash flow, Cash holdings, Dividend, Debt and
Stock issues. Table 1 provides detailed variable definitions. Economic effect measures the difference in either Fixed
investment, R&D/investment or Intangible assets in an industry at the 95th percentile of Pollution intensity relative
to an industry at the 5th percentile in a country at the 95th percentile of Pollution taxes versus a county at the 5th
percentile. Mean top 5% represents the mean value of the dependent for firms located in the top 5% polluting industries.
The standard errors are clustered at the country level. a , b , and c stand for significance at the 1%, 5%, and 10% levels.

(1) (2) (3) (4)

Fixed Fixed R&D/ Intangible
investment assets investment assets
Pollution taxesc,t-1 x –0.005 –0.017 0.020 0.286
b a b
Pollution intensityj (0.002) (0.006) (0.007) (0.108)b

Firm controls Yes Yes Yes Yes

Industry fixed effects Yes Yes Yes Yes
Country-year effects Yes Yes Yes Yes

Economic effect –0.002 –0.005 0.006 0.091

Mean top 5% 0.055 0.368 0.275 0.424
Observations 19,365 22,208 18,477 21,829

37
Table 12: Pollution taxes, pollution intensity and external finance
Table 12 reports OLS estimates of equation (1) with R&D as the dependent variable. All regressions include four digit
SIC level industry fixed effects and country-year fixed effects and firm control variables: Firm size, Firm age, Sales
growth, Sales, Cash holdings, Debt and Stock issues. Table 1 provides detailed variable definitions. Column (1) (column
(2)) include firms above (below) the median in average cash flow over the sample period, and column (3) (column (4))
include firms above (below) the median in average dividend over the sample period. Economic effect measures the
difference in either financing variable in an industry at the 95th percentile of Pollution intensity relative to an industry
at the 5th percentile in a country at the 95th percentile of Pollution taxes versus a county at the 5th percentile. Mean
top 5% represents the mean value of the dependent for firms located in the top 5% polluting industries. The standard
errors are clustered at the country level. a , b , and c stand for significance at the 1%, 5%, and 10% levels.

(1) (2) (3) (4)

Cash flow Dividend
High Low High Low
Pollution taxesc,t-1 x 0.005 –0.035 0.009 –0.017
Pollution intensityj (0.001)a (0.022) (0.003)b (0.013)

Firm controls Yes Yes Yes Yes

Industry fixed effects Yes Yes Yes Yes
Country-year effects Yes Yes Yes Yes

Economic effect 0.002 – 0.003 –

Mean top 5% 0.026 0.026 0.026 0.026
Observations 10,663 10,149 11,400 9,412

38
Table 13: Pollution taxes, pollution intensity and distance to frontier
Table 13 reports OLS estimates of equation (1) with R&D as the dependent variable. All regressions include four digit
SIC level industry fixed effects and country-year fixed effects and the following firm control variables: lagged dependent
variable, Firm size, Firm age, Sales growth, Sales, Cash flow, Cash holdings, Dividend, Debt and Stock issues. Reform
is an indicator variable taking on the value one (zero) in the year a country first introduces the pollution tax and
afterwards (see Table 2 for the dates of each country’s introduction) (otherwise). Table 1 provides detailed variable
definitions. A firm is considered close to (far from) the technological frontier if it is above (below) the median in distance
to the maximum R&D intensity of the four digit industry it operates in. Economic effect measures the difference in
R&D in an industry at the 95th percentile of Pollution intensity relative to an industry at the 5th percentile in a
country at the 95th percentile of Pollution taxes versus a county at the 5th percentile. Mean top 5% represents the
mean value of the dependent for firms located in the top 5% polluting industries. The standard errors are clustered at
the country level. a , b , and c stand for significance at the 1%, 5%, and 10% levels.

(1) (2) (3) (4)

Close to frontier Far from frontier
Pollution taxesc,t-1 x 0.007 – 0.000 –
Pollution intensityj a
(0.002) (0.001)

Reformc,t x – 0.019 – 0.002

Pollution intensityj b
(0.009) (0.003)

Firm controls Yes Yes Yes Yes

Industry fixed effects Yes Yes Yes Yes
Country-year effects Yes Yes Yes Yes

Economic effect 0.002 0.002 – –

Mean top 5% 0.026 0.026 0.026 0.026
Observations 10,447 10,365 10,447 10,365

39
Table 14: Pollution taxes and patenting in air pollution abatement
technologies
Table 14 reports OLS estimates with All patents as the dependent variable in columns (1) and (2) and Triadic patents in
columns (3) and (4). All patents is one plus the natural logarithm of the stock of all patents in air pollution abatement
technologies by country and year and Triadic patents is one plus the natural logarithm of the stock of triadic patents
in air pollution abatement technologies by country and year in columns (3) and (4). All regressions include country
and year fixed effects and ln(GDP per capita) and ln(GDP). The standard errors are clustered at the country level. a ,
b , and c stand for significance at the 1%, 5%, and 10% levels.

(1) (2) (3) (4)

All patents Triadic patents
Pollution taxesc,t-1 0.085 0.042 0.088 0.056
c c b
(0.045) (0.021) (0.039) (0.023)b

All patentsc,t-1 – 0.511 – –

a
(0.065)

Triadic patentsc,t-1 – – – 0.414

(0.062)a

Country fixed effects Yes Yes Yes Yes

Year fixed effects Yes Yes Yes Yes
Country controls Yes Yes Yes Yes

Observations 352 352 352 352

40