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Corrective Ad Valorem and Unit Taxes : A Welfare Comparison

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Author Info
Susanne Dröge
Philipp J. H. Schröder

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Abstract

The ad valorem versus unit taxes debate has traditionally emphasized tax yield. For 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. Yet, in a number of policy fields, such as environmental, health or trade economics, policy makers apply taxes to target the production/consumption volume in an industry, i.e. aim at a certain corrective effect rather than 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.

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Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 534.

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Length: 18 p.
Date of creation: 2005
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Handle: RePEc:diw:diwwpp:dp534

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Keywords: Externalities Monopolistic competition Taxes Specific taxes Welfare

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Find related papers by JEL classification:
H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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    Other versions:
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    Other versions:
  15. Skeath, Susan E. & Trandel, Gregory A., 1994. "A Pareto comparison of ad valorem and unit taxes in noncompetitive environments," Journal of Public Economics, Elsevier, vol. 53(1), pages 53-71, January. [Downloadable!] (restricted)
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