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Consumption Tax Reform and the Real Economy: Evidence from India’s Adoption of a Value-Added Tax

Abhay Aneja (), Nirupama Kulkarni () and S.K. Ritadhi ()
Additional contact information
Abhay Aneja: UC Berkeley School of Law
Nirupama Kulkarni: CAFRAL
S.K. Ritadhi: Ashoka University

No 48, Working Papers from Ashoka University, Department of Economics

Abstract: We study the impact of a consumption tax reform on firm capital and productivity by examining India’s replacement of the sales tax with a value-added tax (VAT). Unlike the sales tax, the VAT allowed firms to offset their tax liability with VAT paid on capital inputs, effectively reducing the tax-related cost of capital. Exploiting the staggered adoption of the tax reform across Indian states, we show that VAT adoption increased firm capital by 3%. The effects are driven by financially-constrained firms – an important source of heterogeneity in a developing country context. We also document a corresponding improvement in the productivity of financially constrained firms. Our findings thus suggest that beyond revenue generation, consumption tax reforms can have the additional effect of stimulating investment and productivity in resource constrained environments.

Keywords: Value-added taxes; financial constraints; consumption tax reform; capital misallocation (search for similar items in EconPapers)
Pages: 64 pages
Date: 2021-01
New Economics Papers: this item is included in nep-pbe and nep-pub
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