Taking China’s environmental “fee-to-tax” reform as a quasi-natural experiment, this paper employs a difference-in-differences (DID) approach to examine the impact of the green tax reform on firms’ cost of equity on a sample of A-share listed firms from 2012 to 2023. The results show that the implementation of the Environmental Protection Tax Law significantly reduced the cost of equity for heavily polluting firms. This finding remains robust after a series of robustness checks. Analyses of the underlying mechanisms reveal that the green tax reform lowered the cost of equity primarily through the channel of “Porter effect.” Moreover, the effect is more pronounced among firms located in the eastern China, those with stronger internal governance, and those operating in a stricter external monitoring environment.

The role of Market-incentive environmental regulation (MIER) within the framework of environmental governance is patently evident. While extant literature lauds the advantageous outcomes attributed to the environmental protection tax (EPT) which as a representative of MIER, our empirical inquiry presents a contrasting narrative. By employing the sophisticated Difference-in-Difference-in-Difference (DDD) methodology and utilizing data from A-share listed firms in Shanghai and Shenzhen from 2015-2022, our investigation reveals a significant decrease in firms’ total factor productivity (TFP) following the implementation of EPT. Our core assertion is fortified through the discernment of two plausible mechanisms, namely, the production downsizing effect and the production capital crowding-out effect. Building upon this revelation, we delve into the nuanced pathways through which firms can strategically mitigate the impacts of EPT, encompassing the enhancement of human capital, amplification of research and development (R&D) investments, and fortification of overall firm resilience. Heterogeneity analysis discloses a notably heightened impact of EPT on TFP of state-owned enterprises (SOEs), larger enterprises and enterprises located in eastern regions. Ultimately, an approximately cost-benefit analysis conclusively demonstrates that the benefits derived from EPT far surpass the costs incurred by the concomitant industrial output reduction, which further illustrates the rationale for the implementation of EPT.