Working Paper: CEPR ID: DP13971
Authors: Lucie Gadenne; Roland Rathelot; Tushar Nandi
Abstract: Do tax systems distort firm-to-firm trade? This paper considers the effect of tax policyon supplier networks in a large developing economy, the state of West Bengal in India.Using administrative panel data on firms, including transaction data for 4.8 millionsupplier-client pairs, we first document substantial segmentation of supply chains betweenfirms paying Value-Added Taxes (VAT) and non-VAT-paying firms. We then developa model of firms’ sourcing and tax decisions within supply chains to understandthe mechanisms through which tax policy interacts with supply networks. The modelpredicts partial segmentation in equilibrium because of both supply-chain distortions(taxes affect how much firms trade with each other) and strategic complementaritiesin firms’ decision to pay VAT. Finally, we test the model’s predictions using variationsover time within firm and within supplier-client pairs. We find that the tax system distortsfirms’ sourcing decisions, and evidence of strategic complementarities in firms’ taxchoices within supplier networks. These two mechanisms explain a substantial share ofthe supply chain segmentation that we observe.
Keywords: Taxation; Supplier Networks; Value-Added Tax; Firm-to-Firm Trade
JEL Codes: F14; H25; O23; L14; D22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Firms' sourcing decisions (D21) | Supply chain segmentation (L14) |
| Tax system (H20) | Supply chain segmentation (L14) |
| Tax system (H20) | Firms' sourcing decisions (D21) |
| VAT-paying suppliers (H25) | Firms' choice to pay VAT (H32) |
| Firms' choice to pay VAT (H32) | Sourcing behavior (D16) |