Evidence from Notches in China’s Value-Added Taxes

Speaker: Dr Haishan Yuan

Affiliation: The University of Queensland

Location: Level 6 Boardroom (629), Colin Clark Building (#39), St Lucia Campus

Microsoft Teams: https://teams.microsoft.com/meet/42479477765668?p=Mo75WMOeZIBHDobgN9

Meeting Passcode: VR7WR2Ly

Abstract: Compared with a turnover tax or sales tax, a value-added tax (VAT) avoids repeated taxation of intermediate inputs and gives firms a reason to ask suppliers for creditable invoices. Those advantages come with paperwork. Full VAT compliance requires accounts, invoices, filings, and exposure to audit, costs that can be large for small firms. In China, firms above sector-specific revenue thresholds must register as general taxpayers. Firms below the threshold may remain small-scale taxpayers. They cannot issue special VAT invoices on their own and cannot deduct input VAT, so their tax treatment is closer to a turnover tax than to a full VAT. They also face lower rates and simpler reporting rules. If that simpler status is valuable enough, firms near the cutoff may try not to cross it. Using a nationwide administrative dataset and the local polynomial density estimator of Cattaneo, Jansson, and Ma (2020), we find clear bunching just below China's VAT registration thresholds. The pattern suggests that marginal firms avoid entering the full VAT system by keeping reported revenue below the cutoff, through underreporting, real output reductions, or both. Other reported financial variables—payroll, assets, costs, and profits—are smooth through the manufacturing cutoff, suggesting that the response operates at least partly through reporting rather than real output. The response also varies across space. Among manufacturers, bunching is strongest in counties with many small firms. We do not find the same gradient for wholesale and retail firms. This sectoral contrast is consistent with network externalities in VAT formalization.