The response of firms to eligibility thresholds: Evidence from the Japanese value-added tax

It is common to define benefit eligibility for small business policies by restrictions on the firm size. This paper documents the effects of the value-added tax (VAT) threshold in Japan, focusing on the incentives for a large firm to "masquerade" as many small firms by separately incorporating business segments. A comparison of the corporate size distributions before and after the VAT introduction of 1989 shows a clustering of corporations just below the threshold-a pattern that is attributable to the behavioral responses. To rule out the confounding influences of the changes in the company attributes over the years, we applied a semiparametric density decomposition technique developed by DiNardo, Fortin, and Lemieux (DiNardo J., Fortin N.M., Lemieux T., Labor market institutions and the distribution of wages, 1973-1992: a semiparametric approach. Econometrica 1996; 64; 1001-1044). This study suggests that the masquerading behavior by firms may be commonplace in other settings.