BT-to-VAT reform and firm productivity: Evidence from a quasi-experiment in China

China recently initiated a major tax reform to convert business tax to value-added tax (BT-to-VAT reform), which opened up the tax deduction chain between industries. We used difference-in-differences model and an administrative firm-level dataset from 2011 to 2017 to explore the effect of BT-to-VAT reform on productivity. We found that in contrast to control firms, this reform increased the productivity of the treated firms by 14.6% on average. The positive effects tended to be strengthened in private, large-scale, and capital-intensive firms, as well as in firms with tight financing constraints. Moreover, these positive results of the BT-to-VAT reform appeared to be driven by its positive effect on fixed asset investment, R&D expenditure, and specialization. These findings demonstrate the transformation of tax system has multiple economic effects in developing countries. • We developed a DD model to test the effect of converting business tax to value-added tax reform on productivity in China. • We found that the reform had a significantly positive effect on the firm's TFP. • We found the reform led to tax deduction and bring additional cash flow for treated firms. • The reform stimulate treated firm to increase their investments, R&D expenditures and outsourcing behavior. • Our results provide valuable tax policy implications for many countries in this transition.