Saturday, 19 March 2011: 11:50
In order to stimulate the economy in the 2008 financial crisis, in 2009 China adopted a tax incentive, which allows the firms to exempt VAT tax from the fixed capital investment, changing the previous production type of VAT tax to the consumption type. It is hoped the tax reform would stimulate economic growth and employment. However, the change of VAT tax system may also cause a distortion in the relative factor prices, which will lead to a substitution effect from labor to capital. Hence, the net impacts of the VAT tax reform on macroeconomic variables such as growth and employment are not unambiguous, and, need to be investigated.
This study would apply a CGE model to analyze the impacts on GDP, employment, prices, and government budget balance by the VAT tax reform. We will adopt a Keynesian macroeconomic closure, and, endogenous investment response setup, in a CGE framework, to capture the macroeconomic situation and surplus labor economic environment in China. We will also allow different elasticities of substitution between labor and capital to test the impacts. It is anticipated that the VAT tax has a limited or negative impact on employment but somewhat positive impact on growth. However, other alternatives of tax reduction, such as a uniform VAT tax reduction for all factor inputs, would have better results, given the same cost in the government budget.