Working Paper: CEPR ID: DP12502
Authors: Eugenio J. Miravete; Katja Seim; Jeff Thurk
Abstract: We characterize the trade-off between consumption tax rates and tax revenue -- the Laffer curve -- while allowing for re-optimization by both consumers and firms with market power. Using detailed data from Pennsylvania, a state that monopolizes retail sales of alcoholic beverages, we estimate a discrete choice demand model allowing for flexible substitution patterns between products and across demographic groups while not imposing conduct among upstream distillers. We find that current policy overprices spirits and that firms respond to reductions in the state's ad valorem tax rate by increasing wholesale prices. The upstream response thus limits the state's revenue gain from lower tax rates to only 14% of the incremental tax revenue predicted under the common assumption of perfect competition. The burden of such naive policy falls disproportionately on older, poorer, uneducated, and minority consumers. Upstream collusion exacerbates these effects.
Keywords: Laffer curve; market power; public monopoly; pricing; tax incidence
JEL Codes: L12; L21; L32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| current tax policy in Pennsylvania (H29) | overpriced spirits (L66) |
| reductions in the state's ad valorem tax rate (H79) | increase in wholesale prices (E31) |
| upstream response limits the state's revenue gain from lower tax rates (H71) | only 14% of the incremental tax revenue predicted under perfect competition (D41) |
| naive policy disproportionately affects older, poorer, uneducated, and minority consumers (J18) | exacerbation of negative effects (E71) |
| upstream collusion (L12) | exacerbation of negative effects of naive policy (F68) |
| market power among firms (L11) | significant impact on the shape of the Laffer curve (H21) |
| naive policymaker misestimates potential revenue gains from tax reductions (H27) | poor policy recommendations (D78) |
| failing to account for strategic firm responses (L21) | poor policy recommendations (D78) |
| considering dynamic scoring in tax policy evaluations (H30) | improvement in policy recommendations (D78) |