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.     

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.      

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.     

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.     

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.     

Unit versus ad valorem taxes: Monopoly in general equilibrium

We show that if a monopoly sector is imbedded in a general equilibrium framework and profits are taxed at one hundred percent, then unit (specific) taxation and ad valorem taxation are equivalent on the set of Pareto optima.     

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.     

Consumption taxes in monopolistic competition: a comment

We show that an ad valorem tax is better than an equal-revenue unit tax when consumers spend some fixed proportion of income on taxed goods, when firms use constant mark-up pricing, and entry and exit drive per-firm profit to zero. These key assumptions implies that ad valorem taxes are superior in oligopoly as well as monopolistic competition, showing that earlier results on taxes in monopolistic competition (Schröder in J Econ 83(3):281–292, 2004) are not due to the mode of competition, but rather are due to the functional forms used.     

Resource taxation with heterogeneous quality and endogenous reserves

This paper analyzes the impact of mining taxation on the intertemporal extraction profile for a heterogeneous ore body. The extraction profile specifies both quantities and qualities extracted in each period. Total extraction is thus endogenously determined. The taxes explicitly considered are severance taxes (ad valorem or per unit; on metal or on ore), property taxes, and profits taxes (with depletion allowance). The intertemporal framework integrates economic and geological factors, generating new results on extraction distortions and providing qualification or reconciliation of previous diverse results in this area.     

Oligopoly and the redistribution of market share under commodity taxation

This paper examines the effect of ad valorem and specific commodity taxation on firm market share in a duopoly where firms have different costs. Two reasons suggested for these cost asymmetries are inter-firm differences in efficiency and differences in product quality. When cost differences are efficiency-based, then specific and ad valorem commodity taxation increases the market share of the lower-cost firm and decreases the market share of the higher-cost firm. If the cost difference results from differing product quality, the specific tax increases the market share of the high quality (higher-cost) firm and decreases the market share of the low quality (lower-cost) firm, whereas, the ad valorem tax has just the opposite effect.     

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.     

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 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.     

State Taxation of the Iron Ore Industry in Western Australia

As a contribution to the debate over the taxation of the extractive industries, this article provides estimates of the short run and long run price elasticities of supply for iron ore in Western Australia. Using these estimates, an increase of 1 per cent in the average royalty rate on iron ore is shown to result in a short run decline of 0.61 per cent in the output of iron ore, and a long run decline of 4.36 per cent. It is concluded that raising tax revenue by ad valorem royalties on iron ore leads to a substantial distortion of output, especially after accounting for indirect effects.     

Unit versus Ad Valorem Taxes in Multiproduct Cournot Oligopoly

The welfare dominance of ad valorem taxes over unit taxes in a single‐market Cournot oligopoly is well known. This article extends the analysis to multimarket oligopoly. Provided all ad valorem taxes are equal and positive, unit costs are constant, firms are active in all considered markets, and a representative consumer has convex preferences, ad valorem taxes are shown to dominate in multiproduct equilibrium. Conditions exist, however, under which economic efficiency declines upon replacing specific taxes with ad valorem taxes that preserve output levels. We discuss the roles of unit cost covariances across multiproduct firms, and also of complementarity in demand, in determining the extent of cost efficiencies arising under ad valorem taxation. For goods that are complementary or independent in demand, conditions are found such that industry profits decline upon use of ad valorem taxes.     

Equivalence between fixed fee and ad valorem profit royalty

For an outside innovator with a finite number of buyers of the innovation, this paper compares two licensing schemes: (i) fixed fee, in which a licensee pays a fee to the innovator and (ii) ad valorem profit royalty, in which a licensee leaves a fraction of its profit with the innovator. We show these two schemes are equivalent in that for any number of licenses the innovator puts for sale, these two schemes give the same licensing revenue. We obtain this equivalence result in a general model with minimal structure. It is then applied in a Cournot oligopoly for an outside innovator. Finally, in a Cournot duopoly it is shown that when the innovator is one of the incumbent firms rather than an outsider, the equivalence result does not hold.     

How does a public innovator license a foreign rival?

This paper uniquely considers the optimal two‐part fee of a public firm innovator licensing to a more efficient foreign rival. This is both theoretically interesting and empirically relevant. While previous research emphasises the importance of fixed fees for public firms, we show that, in this case, ad valorem fees typically dominate both fixed fees and per unit royalties. This domination carries over when a private domestic competitor is also added to the market.     

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.     

Industrial heterogeneity and international product cycles

We analyze the superiority of the specific, demand and cost ad valorem subsidies in industrial and export policies. The criterion employed to measure the ranking of the superiority of the subsidy policies in this paper is that, given an identical total output, the smaller the amount of the subsidy, the superior the subsidy policy. We show that the demand ad valorem subsidy is the least efficient policy, regardless of whether it is measured in regard to the industrial or export subsidy policies. The superiority related to the specific and cost ad valorem subsidies hinges upon the production technology. We can thus provide a theoretical explanation to the real world phenomenon as to why governments usually offer a specific or cost ad valorem subsidy policy to agricultural products and exports.     

Foreign competition and optimal privatization with excess burden of taxation

We examine in a mixed oligopoly setting how foreign competition and the excess burden of taxation will affect privatization policy in the presence of strategic tax/subsidy policies. We show that in the presence of excess burden of taxation with foreign competitors, output subsidy coupled with import tariff and partial privatization is adopted to improve the social welfare. However, if the excess burden of taxation is relatively large, the government may switch to use production tax coupled with tariff policy and partial privatization to improve the social welfare.