The Tax Reduction Effect of VAT Reform on Production Networks

【Authors】

NIE Haifeng

【WorkUnit】

Sun Yat-sen University, 510275.

【Abstract】

In recent years, China has carried out major reforms to its Value-Added Tax （VAT） system. The most significant was the 2012-2016 business tax to VAT reform, which eliminated the business tax and extended VAT coverage to nearly all service and industrial sectors. At that time, the VAT system operated with four rates: 17%, 13%, 11%, and 6%. From 2017 to 2019, further reforms simplified the rate structure to three tiers—13%, 9%, and 6%—and introduced a system for refunding excess input VAT credits. In 2022, as part of a broader tax relief package, the government raised the refund rate for certain industries, including manufacturing, from 60% to 100%. These reforms have played a key role in improving the economic structure and promoting high-quality development, serving as important examples of both broad-based and targeted tax reduction policies.
This paper makes two main contributions to the literature. First, it builds a multi-sector general equilibrium model that extends the Long and Plosser （1983） framework to incorporate differentiated VAT rates and input-output linkages. This model shows how VAT rules—such as multiple tax rates, partial input deductions, and carryforward credits—affect industry-level tax burdens and overall output, and that only when all inputs are fully deductible under a single rate can VAT achieve neutrality, avoiding double taxation. However, in reality, partial input deductions and multiple rates distort the tax base and increase effective tax burdens.
Second, the paper quantitatively assesses the impact of VAT reforms on the GDP and sectoral tax burdens. The 2012-2016 reform, by enabling cross-sector input tax deductions, increased the GDP by 0.648%. The 2017-2019 reforms, which merged tax brackets and reduced rates, contributed an additional 0.225% GDP growth. The 2022 refund expansion policy added a modest 0.025% to the GDP. Collectively, these reforms significantly reduced the average industry tax burden, which fell from 5.9% in 2012 to 3.8% in 2022.
Based on the findings, this study offers several policy implications for further VAT reform. First, expanding the scope of deductible inputs can reduce economic distortions caused by VAT. Second, strengthening the input VAT credit refund system is crucial for a well-functioning VAT regime. Third, while simplifying tax brackets is desirable, it must be balanced against other economic and administrative considerations. These insights help inform the ongoing effort to build a more efficient, fair, and modern VAT system in China.
Future research may consider incorporating firm-level heterogeneity to reveal how VAT rate adjustments and input tax credit refund reforms affect corporate investment and innovation decisions, providing deeper insights into the underlying dynamic mechanisms of these tax policy changes.

JEL: H25, H20, E62

【KeyWords】

Production Network, VAT, Tax Reform, Tax Rate Reduction