Supply-side Economics in the People's Republic of China's Regional Context: A Quantitative Investigation of Its VAT Reform

Abstract

The People's Republic of China (PRC) has now decided to shift its value-added tax (VAT) from production-based to consumption-based. This transition is currently piloted in the three provinces of the northeast PRC, and is expected to be extended to the whole country in the coming 2 or 3 years. Using a two-region dynamic general equilibrium model with overlapping generations, this paper investigates the macroeconomic and welfare effects of the VAT transition in PRC. The distribution effects between generations are also analyzed to get a sense of public opinion toward the reform. We put special emphasis on the pace of reform by analyzing the pre-announcement effects and the inter-regional impacts of tax reform that began in one pilot region. The simulation results suggest large welfare gains from the VAT transition. However, the pilot reform in the northeast provinces, which delays the national implementation of consumption-based VAT, would involve substantial transitional costs for the rest of the PRC.