The impact of greater VAT tax neutrality on total factor productivity: Evidence from China’s VAT credit refund reform in 2018

Abstract

Prior to 2018, Chinese enterprises registered for Value Added Tax (VAT) were required to carry forward excess input tax credits indefinitely. Following the 2018 VAT Credit Refund Reform, enterprises became entitled to refunds on excess input tax credits, as is standard in a conventional VAT system. The reform significantly enhanced tax neutrality, which might have been expected to have impacted production efficiency. This study employs a difference-in-differences (DID) method of analysis, using the commencement of the 2018 reform as the focal point, to highlight how from 2014 to 2020 certain Chinese enterprises received fiscal benefits from the reform while others did not. The conclusion is striking; enterprises that were able to obtain VAT refunds increased their total factor productivity by 6.96% compared to those that received no fiscal benefit from the reform. The outcome reflects the impact of the VAT credit refund as a source of financing for these firms, leading directly to increased investment, or, in the case of high-tech enterprises, increased R&D. The impact of this change is particularly pronounced in private enterprises and growing businesses. Our study provides evidence of the benefits of VAT reform in the direction of neutrality by providing swift and full refunds for excess input tax credits.