Commodity Taxes, Wage Determination, and Profits

We examine the effects of two different types of commodity taxation, specific and ad valorem, on wages and profits. We analyze two models of wage determination, one with efficiency wage setting and one with union-firm bargaining. In the former, a (locally) revenue-neutral shift from specific to ad valorem taxation leads to an increase in both employment and wages and a reduction in profitability. In the latter, the effect on wages and profits may be reversed: predominantly ad valorem taxation raises employment but lowers wages, and under certain circumstances, the net effect is an increase in profits.     

Optimal Tax Policy under Environmental Quality Competition

This paper studies the socially optimal emission and commodity tax policy when consumers are willing to pay a price-premium for environmentally friendlier variants of a commodity vertically differentiated in environmental quality. The first-best levels of quality can be obtained by a combination of a uniform ad valorem tax and an emission tax (or a subsidy for buying green products). The first-best emission tax is higher than the social valuation of the positive externality associated with average environmental quality. Regardless of environmentally conscious consumers, if only one instrument is available, the second-best emission tax is equal to the social valuation of the positive externality associated with average environmental quality. A uniform ad valorem tax increases welfare only if the social valuation of the positive externality associated with average environmental quality is low enough.     

The Comparison between Ad Valorem and Unit Taxes under Monopolistic Competition

This paper shows that the welfare dominance of ad valorem over unit taxes under imperfect competition, extends to a Dixit-Stiglitz-type monopolistic competition framework with differentiated products, increasing returns to scale, entry/exit and love of variety. This result is obtained, even though ad valorem taxation leads to increased firm exit compared to the equal-yield unit tax. Yet the smaller tax over-shift, occurring under ad valorem taxation, more than compensates this disadvantage.Acknowledgement Comments and suggestions from Anthony Atkinson, Jürgen Bitzer, Rainald Borck, David Collie, Jan G. Jørgensen and two anonymous referees are gratefully acknowledged.     

On the efficiency of indirect taxes in differentiated oligopolies with asymmetric costs

This paper shows that unit taxation can be welfare superior to ad valorem taxation in asymmetric and differentiated oligopolies if the goods are sufficiently differentiated, the cost variance is sufficiently large and the ad valorem tax rate is sufficiently high. Moreover, this result holds under either Cournot competition or Bertrand competition.      

Specific taxation,asymmetric costs,and endogenous quality

This paper shows how a specific tax—in contrast to an ad valorem tax—alters industry structure and firm-level performance in a monopolistic competition framework, where firms chose product quality endogenously and differ exogenously in productivity (i.e., marginal production efficiency). Industry equilibrium mechanisms and selection based on productivity play a significant role: A specific tax shifts market shares and profits toward firms with costs and prices above the industry average at the expense of low-cost firms. This reallocation of market shares releases a novel scale effect such that low-cost firms may quality downgrade, while high-cost firms always quality upgrade. There exists a parameter subspace, where this combines to a decrease on average quality for the industry. In comparison: An ad valorem tax only reduces the number of firms/varieties in the industry due to demand absorption, but affects neither firm-level performance nor industry structure.     

Comparing ad valorem and specific taxes with corporate social responsibility

This paper examines the welfare ranking of indirect tax systems with corporate social responsibility (CSR) in a duopoly. Findings show that the two firms' cost and CSR asymmetries both play important roles. If the cost-efficient firm has a higher CSR level, the standard result in traditional tax theory is sustainable. Namely, ad valorem tax (specific subsidy) policies are considered superior to specific tax (ad valorem subsidy) policies. However, if the cost-inefficient firm has a significantly higher CSR level, the standard result is reversed. This result remains robust in an oligopoly model or under a tax revenue constraint.     

COMMODITY TAX STRUCTURE AND INFORMAL ACTIVITY

Commodity tax structure affects the firm's choice between formality and informality. An increase in the specific tax rate, relative to an equivalent increase in ad valorem taxation, makes informality attractive to more firms. Formality becomes attractive at lower levels of profits under ad valorem taxation. For both the maximization of welfare subject to a revenue constraint and the unconstrained maximization of revenue, the optimal rate of specific taxation is zero.     

Tax Effects in a Model of Product Differentiation: A Note

We investigate how unit (or specific) tax and ad valorem tax affect equilibrium location choice in a model of product differentiation, which includes Hotelling (linear-city) and Vickrey-Salop (circular-city) spatial models as special cases. We find that neither tax affects equilibrium location patterns as long as each firm has the same production cost. Two taxes can yield different location patterns under cost heterogeneity among firms.     

How should commodities be taxed?: Market structure,product heterogeneity and the optimal structure of commodity taxes

This paper is concerned with the form in which commodity taxes are best imposed, and particularly with the appropriate balance between specific and ad valorem components. This neglected issue is of policy importance in relation to the harmonization of tax structures within the EEC, and of theoretical interest as a point of contact between optimal tax theory and models of non-price competition. The roles of the two taxes as purely corrective devices under a variety of market forms are established and discussed. The analysis suggests that heavily taxed commodities should normally be subject to high specific rather than high ad valorem taxes.     

Commodity taxes under uncertainty

This paper considers the relative distorting effect on output of commodity taxes, specific and ad valorem, in a situation where a firm faces revenue uncertainty. It is shown generally that this effect depends both on the precise nature of the firm's revenue uncertainty and on the degree of its risk aversion. More specifically, the distorting effect of each tax is characterised for a selection of objective functions and uncertain environments. These characterisations are compared in order to show the influence of alternative specifications on the relative distorting effect.     

Choice and design of regulatory instruments in the presence of green consumers

Using a vertically differentiated product model, this paper examines welfare implications of various government policies in a situation where consumers are environmentally discerning. It studies ad valorem taxes/subsidies and emission taxes. The optimal policy depends on the magnitude of damage parameter associated with environmental externality. For a given distribution of tastes and preferences, as the damage parameter increases from a low to a high value, the optimal policy shifts from an ad valorem tax to an ad valorem subsidy. It also shows that for a sufficiently low damage parameter, an ad valorem tax dominates an emission tax.     

Commodity tax structure under uncertainty in a perfectly competitive market

In a partial equilibrium setting without price uncertainty, the balanced-budget substitution of an ad valorem tax on output for a specific (unit) tax can enhance welfare in imperfectly competitive markets and is without impact in a competitive world. This paper demonstrates that a substitution of this kind can also increase expected output and welfare in a competitive market characterised by uncertainty about the commodity price, if firms can respond to the revelation of demand conditions by altering output.     

Edgeworth's taxation paradox when firms engage in cost-reducing investment

This study examines whether and when Edgeworth's taxation paradox, that taxation decreases the equilibrium price, occurs in a free-entry Cournot oligopoly with cost-reducing investment. In contrast to the fact that no paradox occurs in the short-run equilibrium, the paradox can occur in the long-run equilibrium, in which the number of firms is endogenous. However, the conditions under which the paradox occurs are restrictive when there is no investment. By incorporating cost-reducing investments into the model, we demonstrate that the paradox is likely to occur under less restrictive conditions, irrespective of whether the tax is specific or ad valorem.     

Welfare Effects of Commodity Taxation in Cournot Oligopoly

In the context of Cournot oligopoly with possibly asymmetric costs, this paper presents necessary and sufficient conditions for a small specific tax and a small ad valorem tax to increase total surplus. The paper also shows that a shift from a small specific tax to a small ad valorem tax, leaving the tax revenue unchanged, increases the total surplus.
JEL Classification Numbers: D43, H21, L13.     

Correcting Market Failure Due to Interdependent Preferences: When Is Piecemeal Policy Possible?

Allowing for general utility interdependence and agent heterogeneity, we characterize taxes that will generate first best solutions in markets. We show the equivalence of tax corrections derived from the Marshallian and compensated demand approaches. Next we analyze the conditions that are required for the market failure to be corrected by: (1) specific indirect ad valorem taxes on commodities, (2) the same proportional tax rate on every commodity, and (3) a proportional income tax rate on each individual. The conditions are related to the restrictions necessary to have H synthetic consumers without externalities who replicate behavior of individuals with externalities.     

Commodity taxes and welfare under endogenous market conduct

We consider consumption taxes in a model of endogenous Cournot versus Bertrand competition. It is argued that when the choice of unit versus ad valorem taxes affects longer-term decisions beyond the customary price or quantity decisions, the mix of the two taxes co-determines market conduct. This gives ad valorem taxes an anti-competitive effect that harms ad valorem taxes’ efficiency in comparison with unit taxes. We show that a mix of the taxes—or a unit tax alone if we compare one or the other of the taxes—is sometimes welfare superior on account of consumer-price and tax revenue effects. A practical implication of our findings is that pass-through rates are only sometimes useful guides for policy. In fact, we show when the proper response to demand for higher revenue is a higher unit tax rate and a lower ad valorem tax rate.     

Ad valorem versus unit taxes: monopolistic competition, heterogeneous firms, and intra-industry reallocations

Real-world industries are composed from heterogeneous firms and substantial intra-industry reallocations take place, i.e. high productivity firms squeeze out low productivity firms. Previous tax-tool comparisons have not included these central forces of industry structure. This paper examines a general equilibrium monopolistic competition model with heterogeneous firms and intra-industry reallocations. We show that the welfare superiority of ad valorem over unit taxes under imperfect competition is not only preserved but amplified. The additional difference between the tools arises because unit taxes distort relative prices, which in turn reduces average industry productivity through reallocations (the survival and increased market share of lower productivity firms). Importantly, numerical solutions of the model reveal that the relative welfare loss from using the unit tax increases dramatically in the degree of firm heterogeneity.     

A Note on Ad Valorem and Per Unit Taxation in an Oligopoly Model

This note shows that per unit taxation welfare dominates ad valorem taxation in an oligopoly model, when the number of consumers is sufficiently high compared to the number of oligopolists. It aims to provide an alternative perspective to existing literature arguing instead the dominance of ad valorem over per unit taxation in oligopoly frameworks. Our result is obtained in a simple example which uses a strategic market game formulation to study strategic behavior at a general equilibrium level.     

On the distributional effects of commodity taxation

A commodity tax system is inequality reducing if the after‐tax distribution of income Lorenz dominates the before‐tax distribution of income, regardless of initial conditions. This paper identifies necessary and sufficient conditions under which an ad valorem commodity tax system is inequality reducing, shedding light on the role of taxing luxury—as opposed to necessary—commodities in the equalization of after‐tax incomes.     

Taxation under oligopoly in a general equilibrium setting

Taxation under oligopoly is analyzed in a general equilibrium setting where the firms are large relative to the size of the economy and maximize the utility of their shareholders. Assuming that preferences are either identical and homothetic or identical and quasi‐linear, then the oligopoly model is an aggregative game, which greatly simplifies the comparative statics for the effects of taxation. This novel analysis of taxation leads to a number of counterintuitive results that challenge conventional wisdom in microeconomics. A lump‐sum tax may increase the price of the oligopolistic good and decrease welfare whereas a profits tax may decrease the price of the oligopolistic good and increase welfare. A profits tax is shown to be superior to a lump‐sum tax. Furthermore, in line with conventional wisdom, total tax revenue is always higher with an ad valorem tax than with a specific tax that leads to the same price for the oligopolistic good.