The impact of tax reduction policies on fine and confiscation revenues: Evidence from China’s VAT reform

Tax cuts may stimulate economic growth while tightening local fiscal constraints. Leveraging China’s VAT reform as a quasi-natural experiment, we examine whether local governments offset tax revenue losses by increasing fine and confiscation revenues. We manually compiled a dataset of administrative penalties and implemented a difference-in-differences regression approach. We find a significant post-reform increase in fine and confiscation revenues, providing evidence of a tax-fee substitution effect. The effect is more pronounced in regions with weaker business environments and is concentrated in authorities with greater enforcement discretion. Mechanism tests indicate that fiscal pressure, interacting with enforcement discretion, drives the increase in fine and confiscation revenues. Our findings reveal an unintended fiscal consequence of tax-cut policies. The design of tax reduction policies should fully account for local fiscal incentives to mitigate behavioral distortions that could undermine policy effectiveness.