Value‐added Tax and Leverage: Evidence from China's Value‐added Tax Rate Reform

Abstract This paper uses China's value‐added tax (VAT) rate reform as a quasi‐natural experiment to identify the impacts of VAT rate shocks on corporate financial leverage. The results indicate that the reform reduced corporate total leverage significantly. There was a decrease in short‐term leverage, but long‐term leverage showed no significant change. These results remained robust across a series of robustness checks. Mechanism analysis shows that increasing profitability and improving cash flows acted as intermediary channels for the reform's impact on leverage. The reform also contributed to the mitigation of the asset–liability mismatch problem and the reduction of debt risk, while having no apparent impact on corporate investments. Finally, enterprises with more elastic demand and those with lower intermediate input ratios were affected most by the deleveraging effect of the VAT rate reform. This study suggests how the VAT rate cut shaped corporate capital structure. It thus helps to explain the economic consequences of VAT rate shocks.