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 eq...

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Bibliographic Details
Published in:Journal of public economic theory 2021-10, Vol.23 (5), p.1022-1051
Main Authors: Schröder, Philipp J. H., Sørensen, Allan
Format: Article
Language:English
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Summary: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.
ISSN:1097-3923
1467-9779
DOI:10.1111/jpet.12491