Size-dependent VAT, Compliance Costs, and Firm Growth

We examine how firms' responses to a size-dependent tax policy depend on their productivity and compliance costs. To do so, we explore the value-added tax (VAT or Consumption Tax) in Japan, which gives firms an exemption from filing a consumption tax report and remitting tax to the tax authority if their sales are at or below a certain threshold. We use a massive firm-level dataset from Japan to test the following empirical hypotheses that are based on our theoretical analyses. First, firms are more likely to restrain their sales at the threshold, which results in "bunching," if their productivity is in the middle range. Second, such middle-productivity firms are more likely to bunch when the compliance cost is higher. The estimation results support these hypotheses and indicate that firm-level heterogeneity, both in terms of productivity and compliance cost, matters for the bunching of these firms.