Does VAT have higher tax compliance than a turnover tax? Evidence from China

Abstract

We study the tax compliance effects of value-added tax (VAT) by exploiting the reform replacing business tax (BT) with VAT in China beginning in 2012. We find that replacing the BT with VAT significantly increases reported sales and reported cost for treated firms, and the impact is much stronger among business-to-business (B2B) transactions than business-to-consumer (B2C) transactions. Buyers in B2B transactions have stronger incentives to claim invoices to credit their output VAT and reduce their tax liabilities. In B2C transactions, individual consumers do not need VAT credit, so the reform has little impact. Moreover, firms report higher costs after the reform to offset their tax liability. The results indicate that VAT has higher tax compliance than a turnover tax and the VAT system has self-enforcing properties in B2B transactions.