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Efficiency and Incidence of Taxation with Free Entry and Love-of-Variety

Author

Listed:
  • Kroft Kory
  • Laliberté Jean-William
  • Leal Vizcaíno René
  • Notowidigdo Matthew J.

Abstract

We develop a theory of commodity taxation featuring imperfect competition along with love-of-variety preferences and endogenous firm entry and exit, and we derive new formulas for the efficiency and pass-through of specific and ad valorem taxes. These formulas unify existing canonical ones and feature a new term capturing the effect of variety on consumer surplus. Intuitively, if taxes reduce product varieties in the market, then the impact on social welfare depends on how much consumers value variety. As a proof-of-concept, we use the theoretical formulas to identify love-of-variety preferences in an empirical application. Our welfare analysis shows that the marginal excess burden of taxation is very sensitive to the estimated love-of-variety, which can overturn classical results on the desirability of ad valorem versus specific taxation.

Suggested Citation

  • Kroft Kory & Laliberté Jean-William & Leal Vizcaíno René & Notowidigdo Matthew J., 2023. "Efficiency and Incidence of Taxation with Free Entry and Love-of-Variety," Working Papers 2023-20, Banco de México.
    • Handle: RePEc:bdm:wpaper:2023-20
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    File URL: https://www.banxico.org.mx/publications-and-press/banco-de-mexico-working-papers/%7B5C2CFC7A-776F-6C85-3098-27B3110B4A50%7D.pdf
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    More about this item

    Keywords

    Public economics; Taxation; Tax incidence; Sales tax;
    All these keywords.

    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H22 - Public Economics - - Taxation, Subsidies, and Revenue - - - Incidence
    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue

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