Working Paper: NBER ID: w26336
Authors: Zhao Chen; Xian Jiang; Zhikuo Liu; Juan Carlos Suárez Serrato; Daniel Xu
Abstract: We incorporate the lumpy nature of firm-level investment into the study of how tax policy affects investment behavior. We show that tax policies can directly impact the lumpiness of investment. Extensive-margin responses to tax policy are key to understanding the effects of different tax reforms and to designing effective stimulus policies. We illustrate these results by studying China's 2009 VAT reform, which lowered the tax cost of investment and reduced partial irreversibility|the price gap between new and used capital. Using administrative tax data and a difference-in-differences design, we estimate a 36% investment increase. This effect is driven by investment spikes, which is consistent with the reduction of VAT-induced partial irreversibility. Using a dynamic investment model that fits the reduced-form effects of the reform, we show that policies that directly reduce the likelihood of firm inaction are more effective at stimulating investment.
Keywords: Tax Policy; Investment Behavior; VAT Reform; China
JEL Codes: D25; E22; H25
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| 2009 VAT reform (H25) | increase in investment among domestic firms (F23) |
| 2009 VAT reform (H25) | increase in number of firms undertaking large investment spikes (D25) |
| 2009 VAT reform (H25) | increase in fraction of firms investing (G31) |
| reduction in aftertax price gap between new and used capital (H23) | increase in investment (E22) |
| lower likelihood of firm inaction (D22) | more effective at stimulating investment (E22) |
| VAT reform (H25) | more effective than corporate income tax cut for stimulating investment (H32) |