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Does VAT have higher tax compliance than a turnover tax? Evidence from China

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Abstract

We study the tax compliance effects of value-added tax (VAT) by exploiting the reform replacing business tax (BT) with VAT in China beginning in 2012. We find that replacing the BT with VAT significantly increases reported sales and reported cost for treated firms, and the impact is much stronger among business-to-business (B2B) transactions than business-to-consumer (B2C) transactions. Buyers in B2B transactions have stronger incentives to claim invoices to credit their output VAT and reduce their tax liabilities. In B2C transactions, individual consumers do not need VAT credit, so the reform has little impact. Moreover, firms report higher costs after the reform to offset their tax liability. The results indicate that VAT has higher tax compliance than a turnover tax and the VAT system has self-enforcing properties in B2B transactions.

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Notes

  1. Before the reform, a business tax was levied on the provision of services (including transportation, construction, engineering, post and telecommunication, culture, sports, financial services, entertainment, and other lifestyle services), the transfer of intangible assets, and real property. BT rates range from three percent to 20 percent, with most services taxed at five percent. The basic formula of BT is tax payable = turnover × tax rate. The sellers of services can issue the BT invoice to their buyers, but the taxpayer of BT cannot deduct their BT liability by purchasing invoices.

  2. From May 1, 2018, China unified the qualifying criteria of a small-scale VAT taxpayer to an annual turnover of less than RMB 5 million from its previous definition of less than RMB 500,000 and RMB 800,000 for manufacturing and trading companies, respectively.

  3. The VAT rate of 17 percent applied to VAT general taxpayers was reduced to 16% on May 1, 2018.

  4. A small-scale VAT taxpayer is subject to a lower tax rate (3%) based on turnover, has no eligibility for input tax credits on purchases, and has no eligibility to issue special VAT invoices.

  5. The direct tax (i.e., corporate income tax and individual income tax) accounted for 11.47 percent of total tax revenue in 1999 and rose to 29.87% in 2016.

  6. Ministry of Finance and State Administration of Taxation, The Notice on Implementing the Pilot Reform of Levying VAT in lieu of Business Tax on Transportation and certain Modern Services in Shanghai (Caishui [2011] No. 111) and The Notice for the Introduction of the Pilot Scheme to Replace Business Tax with VAT (Caishui [2011] No. 110).

  7. Ministry of Finance and State Administration of Taxation, Notice on Launching the Pilot Collection of VAT in lieu of BT in the Transportation and Certain Modern Service Industries in Bei**g and Other Seven Provinces or Cities, (Caishui [2012] No. 71).

  8. Ministry of Finance (MOF) and State Administration of Taxation (SAT), The Notice on the Nationwide Adoption of VAT in lieu of BT Pilot Tax Collection Policy in the Transportation Industry and Certain Modern Service Industries, (Caishui [2013] No. 37).

  9. Ministry of Finance and State Administration of Taxation, The Notice on Incorporating the Railway Transport Industry and Postal Service into the Pilot Project of the Value-added Tax-for-Business Tax Reform, (CaiShui [2013] No. 106).

  10. Ministry of Finance and State Administration of Taxation, The Notice on Incorporating the Telecommunication Industry into the Pilot Project of the Value-added Tax-for-Business Tax Reform, (CaiShui [2014] No. 43).

  11. Ministry of Finance and State Administration of Taxation, The Notice on the Comprehensive Roll-out of the Business Tax to Value Added Tax (B2V) Transformation Pilot Program, (CaiShui [2016] No. 36).

  12. The lifestyle services sectors include hospitality; food and beverage; healthcare; education; cultural and entertainment services; and a general residual category of any other services.

  13. The special VAT invoice comprises three basic copies: a bookkee** copy used as a bookkee** voucher for the seller, a deduction copy used as a tax deduction voucher for the buyer, and an invoice copy used as a bookkee** voucher for the buyer.

  14. GTS was originally built in 1994 with the help of the Word Bank, GTS II was introduced in 2003, and GTS III with a more comprehensive and powerful information system developed nationwide by the end of 2016.

  15. The treated firms are from the following industries: Research and development (R&D) and technical services, information technology (IT) services; cultural and creative services; logistics and ancillary services; certification and consulting services; movable properties leasing, transportation services; broadcasting; film and television services and telecommunication services. The non-treated firms are from the following industries: real estate and construction; and lifestyle services sectors including hospitality, food and beverage, healthcare, education, cultural and entertainment services; and a general residual category of any other services, excluding financial services.

  16. These sectors subject to VAT include the sale of all goods except for intangible and immovable property as well as processing, repair, and replacement services.

  17. The mean of retail share is 0.36, and the standard deviation is 0.34.

  18. We thank the referee for suggesting a discussion of the potential real response to the tax rate change.

  19. http://www.chinatax.gov.cn/n810219/n810744/n2048831/n2048836/c2606446/content.html.

  20. Since 1994, Shanghai has nominally had two tax agencies—the LTB (Local Taxation Bureau) and the SAT (State Administration of Taxation)—but the agencies and faculties of the LTB and the SAT in Shanghai are the same. In Tibet, in contrast, the SAT is in charge of all tax collection, and there is no LTB. According to the decisions and arrangements of the CPC Central Committee and the State Council for state and local tax institutional reform, China began merging the LTB and SAT in February 2018, and all combined provincial tax authorities unveiled their plaques in June 2018.

  21. We are not using firms in Tibet here because only 5 firms are from Tibet in our sample.

  22. http://english.gov.cn/premier/news/2016/04/05/content_281475321236568.htm

  23. According to the circular named Guofa [2016] No. 26 (Regarding the transitional program for the allocation of the VAT income between the central and local governments after the comprehensive rollout of the BT to VAT reform), all VAT revenues collected in every region since May 1, 2016, have been split 50-50 between the central government and the local government. From 2012 to May 1, 2016, the VAT revenues remitted in the form of BT prior to the BT-to-VAT reform continue to be assigned to local governments.

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Acknowledgements

We thank Joel Slemrod for thoughtful discussion and comments. We thank the editor-in-chief Ron Davies for his valuable comments and suggestion. Any remaining errors are our own. This research was supported by MOE (Ministry of Education in China) Project of Humanities and Social Sciences (No. 19YJA790039).

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Authors and Affiliations

  1. School of Public Finance and Taxation, Southwestern University of Finance and Economics, Chengdu, China

    Jianjun Li

  2. Department of Economics, University of Michigan, Ann Arbor, USA

    Xuan Wang

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Appendix

Appendix

See Tables 12, 13, and 14.

Table 12 Covariates imbalance tests
Full size table
Table 13 Impact of the BT-to-VAT reform on sales and the costs report
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Table 14 Mechanism: incentives from different buyers
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Li, J., Wang, X. Does VAT have higher tax compliance than a turnover tax? Evidence from China. Int Tax Public Finance 27, 280–311 (2020). https://doi.org/10.1007/s10797-019-09567-4

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