The response of small firms to VAT incentive: evidence from South Korea

Abstract

Using a comprehensive dataset of firm-level administrative value added tax (VAT) filings, this study investigates the behavioral responses of small firms to tax incentives. In South Korea, the standard VAT rate has remained at 10% since the introduction of the VAT system in 1977. However, small firms with a total annual revenue below 48 million KRW (approximately $46,000) benefit from a reduced VAT rate under the simplified VAT regime. This study uncovers an excess mass of firms in the revenue distribution precisely at the 48 million KRW threshold. Importantly, this response pattern varies depending on factors such as business sectors, the geographic location of firms and the year of their establishment. The disparities in tax liabilities at the threshold are identified as one of the potential factors driving these results.