The welfare comparison of corrective ad valorem and unit taxes under monopolistic competition

The ad valorem versus unit tax debate has traditionally emphasized tax yield. On this criterion, ad valorem taxes outperform unit taxes in terms of welfare for a wide range of imperfect competition settings including Dixit–Stiglitz monopolistic competition. However, in a number of policy fields such...

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Bibliographic Details
Published in:International tax and public finance 2009-04, Vol.16 (2), p.164-175
Main Authors: DrOege, Susanne, SchrOeder, Philipp JH
Format: Article
Language:English
Subjects:
Ad valorem taxes
Business Taxation/Tax Law
Consumers
Consumption
Economics
Economics and Finance
Equilibrium
Externalities
Externality
H23
L13
Market exit
Monopolistic competition
Product differentiation
Public Finance
Specific taxes
Studies
Subsidies
Tariffs
Tax revenues
Taxation
Taxes
Welfare
Welfare economics
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Summary:The ad valorem versus unit tax debate has traditionally emphasized tax yield. On this criterion, ad valorem taxes outperform unit taxes in terms of welfare for a wide range of imperfect competition settings including Dixit–Stiglitz monopolistic competition. However, in a number of policy fields such as environmental, health, and trade economics, policy makers use taxes to reduce the production/consumption volume in an industry, i.e., to correct an externality rather than to improve tax yield. This paper compares the two tax instruments with respect to equal corrective effect in a Dixit–Stiglitz setting with love of variety, entry, exit, and redistribution of tax revenues. We find that unit taxes lead to more firms in the industry, less output per firm, less tax revenue, but higher welfare compared to ad valorem taxes.
ISSN:0927-5940
1573-6970
DOI:10.1007/s10797-007-9061-9