The impact of value-added tax reform on small and medium-sized firm innovation: Evidence from China

Abstract

Taxation is pivotal in the government’s efforts to shape and regulate enterprise behavior. The business tax replaced with value-added tax (VAT) reform in China aims to lessen overall tax burden and enhance enterprise vitality. One important performance indicator of the reform is its impact on enterprise innovations. Focusing on small and medium-sized enterprises, we apply a difference-in-differences model to examine the impact of the VAT reform on innovation output and efficiency. Results reveal an insignificant overall impact of the reform on the innovation of small and medium-sized enterprises. Among them, the reform indeed significantly inhibited the innovation of technological firms. We find that the input tax deductions failed to lower the tax burden for technological firms, while the increase in applicable tax rate led to a more significant tax burden. Therefore, China’s VAT reform was ineffective in improving small and medium-sized enterprise innovation. We thus suggest a need to redesign the elements in the reform to enhance its performance.