Nothing comes for free: Evidence from a tax reduction of China

Using data from the National Taxation Survey from 2009 to 2015, this paper conducts a quasi-natural experiment on the tax reduction reform of "replacing business tax with value-added tax" (RBTVT) in China to empirically explore the impact of the fiscal pressure caused by the turnover tax reduction on the corporate income tax burden. The paper tries to explain why it is difficult to reduce the tax burden through tax reduction from the perspective of fiscal pressure. According to the empirical results, an extensive tax reduction creates a "tax substitution" effect, i.e., the stronger the tax reduction effect of the RBTVT, the greater the motivation of local governments will be to shift the fiscal pressure to enterprises through taxation, resulting in an increased local corporate income tax burden. In regards to "who pays the tax", the paper indicates that non-state-owned enterprises, small and micro enterprises, and non-RBTVT enterprises are the main bearers of the local fiscal pressure shift. With further examination, the paper finds that there is an obvious "tax substitution" effect in regions with poor business environments or large governments. In the mechanism section, the paper finds that strengthening tax administration, decreasing tax-rate reductions for enterprises, and levying excessive tax are the primary "tax substitution" methods. In the extended analysis, our results suggest that enterprises are not the ultimate bearers of fiscal pressure because they can shift the pressure on them to workers by reducing the cost of wages and benefits. Besides, the results show that cutting fiscal expenditure and improving fiscal expenditure efficiency can effectively alleviate the "tax substitution" effect. Finally, we find that the "tax substitution" effect discounts the impact of tax reduction, but does not entirely nullify it.