Working Paper: CEPR ID: DP2107
Authors: Chaim Fershtman; Neil Gandal; Sarit Markovich
Abstract: The incidence of taxation and the design of an optimal tax system have been extensively discussed in the public finance literature but mainly within a competitive market setting or within a homogenous good (Cournot type) oligopoly. In a differentiated product oligopoly, the effect of taxation can be more complex as the rate of taxation may affect not only the prices, but also the profile and quality of products that are sold in the market. In this paper, we examine the effects of changing tax regimes in a differentiated product oligopoly. In order to illustrate our approach, we employ data from one such market: the automobile market in Israel. The analysis involves two steps. We first estimate the Nash equilibrium in a differentiated product oligopoly and then use the results to simulate the new equilibrium under different tax regimes. Using the estimated parameters from the current market equilibrium, we examine the effect of changes in tax policy on tax incidence, market prices, sales (and the types of cars sold in the market), consumer surplus, firms' profits, as well as government revenues.
Keywords: taxation; differentiated product oligopoly
JEL Codes: H2; L8
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Change in tax regime from ad valorem tax to per unit tax (H25) | Significant reductions in the sales of small automobiles (F61) |
| Change in tax regime from ad valorem tax to per unit tax (H25) | Increases in the sales of large automobiles (L62) |
| Change in tax regime from ad valorem tax to per unit tax (H25) | Firms respond by lowering prices (L11) |
| Degree of product differentiation and market power (L11) | Influences pricing strategies and consumer choices (L11) |
| Oligopolistic model captures nuances of consumer behavior and firm responses more accurately than competitive frameworks (D43) | Overestimates reductions in government tax revenue and consumer surplus gains when tax rates are lowered (H23) |