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-sector multi-country Ricardian model to examine the extent to which these de facto export tax changes 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 trade 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 on VAT exports provided a small effect overall on the welfare of China and trading partners, although some countries lost as much as 2/3 of their gain from China’s liberalization based on tariffs alone. We also use our model to solve for China’s optimal export taxes and calculate the impact of optimal export taxes on China and the rest of the world.