Abstract: The tax reduction policy will lead local governments to development dilemma of imbalanced fiscal revenue and expenditure. Improving the quality and efficiency of fiscal and taxation policies is of great significance in guaranteeing the policy space of China’s tax and fee reduction and maintaining the local fiscal sustainability. With the help of the pilot reform of “replacing business tax with VAT”to capture the exogenous changes of the tax reduction policy, this paper tries to identify the impact of China’s tax reduction policy on the efficiency of local fiscal expenditure and its mechanism by making use of the difference-in-difference model. The findings show that the implementation of the“VAT reform”policy has significantly improved the efficiency of local fiscal expenditures. In order to cope with the fiscal pressure caused by the tax reduction policies, local governments have improved the efficiency of fiscal expenditures by strengthening audit and supervision and optimizing the structure of public expenditures. The greater the degree of fiscal autonomy, intergovernmental competition, fiscal transparency, and marketization, the more obvious the effect of tax reduction policies in improving fiscal expenditure efficiency will be. Therefore, it is suggested that the government should achieve the goal of improving the quality and efficiency of the fiscal and taxation policies from the following four aspects: deepening the reform of the fiscal and taxation system, and improving the fiscal expenditure efficiency during the process of tax and fee reduction; improving the fiscal revenue and expenditure incentive mechanism, and correcting the structural deviation of fiscal expenditure of local governments in“paying more attention on production than service”; allocating the financial power and the authority of office scientifically, and mobilizing the enthusiasm of the central macroeconomic regulating ability and the local financial autonomous ability; deepening the reform of government budget system and financial affairs public system.

Key words: tax reduction policy, replacing business tax with VAT, fiscal expenditure efficiency, fiscal expenditure structure