Are SMEs Avoiding Compliance Costs? Evidence from VAT Reforms in Japan

This study disentangles the motives behind enterprises' responses to size-dependent tax regulations by exploiting value-added tax (VAT) reforms in Japan. Tax threshold and tax rate in Japan have changed over the past three decades since the introduction of VAT. We build on the model of Harju et al. (2019) to incorporate various tax reforms and conducted bunching estimation. By using a novel panel of the Japanese Census of Manufacture covering the periods of VAT introduction and reforms, we find from the local estimates that the observed output response of enterprises is mainly caused by compliance costs rather than tax rates for small enterprises in Japan. The results suggest that the authorities would be better served by easing compliance costs while enhancing tax revenue to improve the efficiency of tax design.