Tax Design and Corporate Liquidity: Evidence from China’s VAT Reform

This paper examines whether a consumption-type VAT that permits input credits relaxes firms’ short-term liquidity constraints. Exploiting China’s 2007 VAT reform as a quasi-natural experiment and firm-level data from the Annual Survey of Industrial Firms for 2002 to 2008, our difference-in-differences estimates indicate that the reform raises treated firms’ current ratio by 0.141, about eight percent of the pre-reform mean. The effect is concentrated among non-state firms, smaller firms, and resource- and labor-intensive industries, and is markedly larger for financially healthy firms (current ratio ≥ 2: +0.44), while liquidity-stressed firms experience no improvement or slight declines. Mechanism tests indicate (i) an income effect—input VAT deductions increase internal funds and profitability (ROA/ROE) and expand current assets—and (ii) a maturity-matching effect—the reform encourages long-term financing for fixed-asset investment, easing short-term liability pressure. Event-study dynamics support parallel trends; results are robust to alternative clustering, matched samples (PSM-DID), and numerous specification checks. The findings show tax design can relax liquidity constraints and reshape liability maturity structure, informing the use of tax policy as a macro-prudential tool.