Consumption Tax Reform And The Real Economy: Evidence From India’s Adoption Of A Value-Added Tax
Author(s) Abhay Aneja, Nirupama Kulkarni and S. K. Ritadhi


We study the impact of consumption tax reform on firm capital and productivity by examining India’s replacement of the pre-existing sales tax with a value-added tax (VAT) structure. This policy allowed firms to offset their tax liability with VAT paid on capital inputs, effectively reducing the tax-related cost of capital. We analyze whether firms responded by increasing their capital investments. Exploiting the staggered adoption of tax reform across major Indian states, we show that adoption of a VAT system increased firm capital by around three percent. Effects are driven by the most 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.

Download Paper