Does Tax Deduction Relax Financial Constraints? Evidence from China’s Value-Added Tax Reform

35 Pages Posted: 10 Mar 2020

See all articles by Jingwen Wang

Jingwen Wang

Tsinghua University, SEM

Guangjun Shen

Central University of Finance and Economics (CUFE)

Dunzhe Tang

Tsinghua University, SEM

Date Written: February 17, 2020

Abstract

Financial constraint is a major obstacle for firm growth, especially in developing countries where credit is scarce. This paper explores the role of tax policy in relaxing firms’ financial constraints by exploiting the exogenous shocks from China’s value-added tax (VAT) reform in 2009. We find that VAT reform significantly reduces effective VAT rate, which in turn improves both internal and external financing capacity for firms through the increase in liquidity, cashflow and commercial credit, and through the decrease in borrowing cost as well. The findings are robust to alternative specifications but show heterogeneity across ownerships, firm sizes, regions and between export and non-export firms. Our analysis suggests tax deduction is useful to relax firms’ financial constraints.

Keywords: Tax Deduction, Financial Constraints, Internal Financing, External Financing, VAT Reform

JEL Classification: D21, E62, G32, H25

Suggested Citation

Wang, Jingwen and Shen, Guangjun and Tang, Dunzhe, Does Tax Deduction Relax Financial Constraints? Evidence from China’s Value-Added Tax Reform (February 17, 2020). Available at SSRN: https://ssrn.com/abstract=3539442 or http://dx.doi.org/10.2139/ssrn.3539442

Jingwen Wang (Contact Author)

Tsinghua University, SEM ( email )

Beijing, Beijing 100084
China

Guangjun Shen

Central University of Finance and Economics (CUFE) ( email )

39 South College Road
Haidian District
Beijing, Beijing 100081
China

Dunzhe Tang

Tsinghua University, SEM ( email )

Beijing, 100084
China

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