Abstract: Tax reduction is an important tool for China to promote the upgrading of manufacturing industry, but it is accompanied by increased fiscal pressure. VAT is an important tax in the manufacturing sector. Can VAT tax reduction effectively promote the upgrading of the manufacturing industry? Further, how to optimize the VAT tax reduction strategy if we want to promote manufacturing upgrading from innovation? First, this paper incorporates VAT, intermediate inputs, innovation and product quality into a unified theoretical framework and introduces two mechanisms, the intermediate input effect and the product innovation effect, to explain the impact of VAT on product quality and finds heterogeneity in the distribution of dominant mechanisms under different industry characteristics. Then, based on the exogenous shock of standardized VAT credit management for agricultural products, this paper estimates the impact of VAT on product quality in the agricultural processing industry and finds that the lower effective VAT rate improves the product quality of firms. Finally, the dominant mechanism analysis illustrates that, for the agricultural processing manufacturing industry, the impact of VAT on product quality is mainly through the product innovation effect. The theoretical and empirical conclusions of this paper have certain policy implications for consolidating VAT burden reduction in manufacturing industry and optimizing VAT tax reduction strategies at the industry level.