Cost Shocks and Production Reorganization: Evidence from India’s Goods and Services Tax Reform

Information Systems and Operations Management

Intervenant: Jing Wu (CUHK)

Salle T004

Abstract:

Manufacturing firms routinely face exogenous cost shocks—such as taxes, tariffs, and regulatory shifts—that alter their cost structures, forcing a fundamental trade-off between reorganizing production to minimize direct costs and maintaining established production “recipes” to preserve efficiency. This paper examines this dilemma using India’s 2017 Goods and Services Tax (GST) reform as a natural experiment, which introduced heterogeneous effective tax changes across plants by unifying taxes and eliminating cascading input taxes. Leveraging granular plant-level data from over 72,000 manufacturing facilities over nine years, we employ a continuous difference-in-differences design to track plant responses. We show that plants facing larger tax increases systematically shift product portfolios toward lower-rate categories and adopt two distinct adjustment strategies: reclassification (minor product modifications that preserve existing production capabilities) and reorganization (fundamental operational restructuring with new inputs). Resource-constrained plants favor reclassification, while larger, capital-intensive plants pursue reorganization. These adjustments, however, come at a substantial operational cost: total factor productivity declines by 2.2 percent for every 10 percentage-point increase in effective tax rates, driven by a “quantity-for-quality” substitution toward lower-quality domestic inputs. Overall, the findings highlight a fundamental cost-efficiency trade-off and provide insights for both managers building operational resilience and policymakers designing large-scale tax reforms.