The empirical evidence on the effects of VAT policy in developing countries is scarce. Using a detailed firm level census panel, the authors study the response of manufacturing firms to the adoption of VAT in Ethiopia. The VAT policy mandated firms with revenue higher than $22000 to register for VAT and the smaller firms to pay a lower turnover tax.
First the paper provides suggestive evidence of firm bunching around the threshold. Second, applying a difference-in-differences strategy with big firms (revenue > $22000) as treated and small firms as controls, and excluding potential bunching firms, the authors find that big firms experience increases in reported revenue, value added, revenue share of taxes paid, revenue share of raw materials, and firm productivity; formality increases relatively more for small firms. VAT increases both revenue efficiency and production efficiency for big firms. These results are driven by whether firms are in concentrated or competitive industries.