Abstract: In order to promote the implementation of “the reform of replacing business tax with value-added tax(VAT)” in all industries and encourage the enthusiasm of subnational governments for the reform, Chinese central government has made some adjustments to the policy of VAT sharing betweencentral and subnational governments. However, these adjustments are merely transitional scheme. Based on the perspective of intergovernmental fiscal relationship, this paper sums up the characteristics of the VAT sharing mechanism from both vertical and horizontal aspects. Through theoretical analysis and quantitative calculations, this paper finds out that the vertical “division before centralization” mechanism and horizontal “origin principle” has led to a growing imbalance inthe allocation of fiscal revenues among provinces, revealing that the damage to horizontal equity is an in herent shortage of the VAT sharing system established since 1994. This paper argues that the key to establish a stable VAT sharing system lies in transferring from the idea of “to be efficient and incentive” to that of “to realize horizontal equity”in terms of the sharing mechanism design instead of seeking a suitable sharing ratio, so as to promote the fiscal equalization among provinces better.

Key words: value-added tax, tax sharing mechanism, division before centralization, origin principle, horizontal equity