Tax reform and investment efficiency: evidence from China's replacement of business tax with VAT

Abstract

PurposeExtensive macro- and micro-economics research has been conducted on China's tax reform, which replaced business tax with value-added tax (VAT). However, existing studies have not clarified the reform's impact on firm-level investment decisions. Hence, this study explored the effect of replacing business tax with VAT on firms' investment efficiency.Design/methodology/approachThe study used 2010–2018 data from China's A-share listed companies and a difference-in-differences (DID) model to explore the effect of the reform on firm-level investment decisions.FindingsThe authors found that China's tax reform has improved investment efficiency in underinvested firms, increased liquidity and decreased the level of reliance on external financing. The tax reform had a greater effect on investment efficiency in firms with lower liquidity and higher external financing reliance. Its effect was also more significant among non-state-owned and small companies.Originality/valueThis study fills the aforementioned research gap by exploring the effects of China's tax reform, thus providing a theoretical reference and a basis for policymaking.