VAT rate dispersion and TFP loss in China's manufacturing sector

•I show considerable dispersion in the effective VAT rate across firms in China.•I use a quantitative model to assess its impact on aggregate production efficiency.•I find the dispersion in the VAT rate results in a loss of 7.9% of GDP on average.

The paper studies dispersion in the effective VAT rate, a directly measurable distortion, across manufacturing firms in China and assesses its impact on aggregate production efficiency through misallocation from 2000 to 2007. Using a model based on Hsieh and Klenow (2009), I find that a revenue-neutral tax reform which eliminates the dispersion in VAT rates alone produces a gain in aggregate TFP in the order of 7.9% of GDP on average in the period 2000 to 2007.