Abstract: As one of the most important tax reforms in recent years, “replacing business tax with VAT” can exert an impact on income distribution through both the income effect of the changed factor income and the consumption effect of the changed consumption spending. Both income effect and consumption effect can raise the income level of all the residents, urban and rural, and narrow the income-distribution gap between the urban and the rural areas. Viewing from the inside of both urban and rural areas, the extension of the areas has narrowed the income-distribution gap between urban and rural areas. But the urban depends mainly on the income effect, while the rural depends mainly on the consumption effect. And because the income effect is bigger than the consumption effect, the extension of the areas has a bigger income-distribution effect on urban households than on rural households. Therefore, we should comprehensively promote the policy of “replacing business tax with VAT”, give play to both of the income effect and the consumption effect, and win the double dividends of promoting economic growth and improving income distribution.

Key words: replacing business tax with VAT; income distribution effect; income effect; consumption effect; the CGE model