Trade and welfare effects of export tax: Theory and evidence from China's incomplete export VAT rebate

While China was reducing tariffs as part of the WTO accession process, it was also effectively restricting exports in some sectors by reducing the rebates of the value added tax (VAT) for exporters. We use a multi-country multi-sector Ricardian model to examine the extent to which these de facto export tax changes have benefited China and nullified the benefits to the rest of the world of China's trade liberalization. We show that trade liberalization benefited China's trading partners both through an improvement in their terms of trade and through a reallocation of resources from protected imported sectors to exportable sectors. We find that the partial rebate policy of VAT on exports provided a small effect overall on the welfare of China and its trading partners, although some countries lost as much as 2/3 of their gains from China's trade liberalization based on tariffs alone. By solving for China's optimal export taxes, we demonstrate that while certain sectors experienced a movement towards the optimal level of export taxes, others deviated from it. This differential adjustment contributed to the limited welfare effect on China. Interestingly, our results indicate that the export tax policies favored downstream sectors within China.