Export Liberalization and Domestic Policy Distortion: Evidence from VAT Rate Dispersion in China

Abstract

Tax policies are implemented with significant degree of distortion across firms. Using data on Chinese firms' value-added tax (VAT) payment, we empirically investigate whether export liberalization affects the within-industry VAT rate dispersion across firms, a direct measure of distortion. Adopting the trade policy uncertainty (TPU) shock upon China's WTO accession as the identification strategy, we use the difference-in-difference approach to show that export liberalization through the removal of TPU significantly decreases the within-industry VAT rate dispersion. This result remains significant throughout a series of robustness checks. Our paper thus highlights another source of gains from trade liberalization through mitigating domestic misallocation.