The value-added tax reform and labor market outcomes: Firm-level evidence from China

The tax incentives designed to stimulate firm investment may have a large and unexpected impact on labor market outcomes. Using a comprehensive data set on Chinese manufacturing firms during the period 1998-2007 with a difference-in-differences approach, we examine the impact of the value-added tax reform in 2004 on the firm-level labor market outcomes. We find that firms in eligible industries and pilot regions (treated firms) enjoying lower costs of purchasing fixed assets under the reform tended to increase capital investment and reduce employment simultaneously relative to firms that did not have tax incentives (the control firms). Compared with the control firms, the treated firms became more capital intensive but had declines in labor share in value added and average wage. We also find that the employment adjustment is associated with increase in the share of skilled workers in terms of engineers and technicians, but not workers with a college degree or higher.