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Corrective Ad Valorem and Unit Taxes: A Welfare Comparison

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  • Susanne Dröge
  • Philipp J. H. Schröder

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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Bibliographic Info

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
Date of revision:
Handle: RePEc:diw:diwwpp:dp534

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Keywords: Externalities; Monopolistic competition; Taxes; Specific taxes; Welfare;

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  1. Gareth Myles, 1996. "Imperfect competition and the optimal combination of ad valorem and specific taxation," International Tax and Public Finance, Springer, Springer, vol. 3(1), pages 29-44, January.
  2. Buchanan, James M, 1969. "External Diseconomies, Corrective Taxes, and Market Structure," American Economic Review, American Economic Association, American Economic Association, vol. 59(1), pages 174-77, March.
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  7. Sofia Delipalla & Michael Keen, 1991. "The Comparison Between Ad Valorem and Specific Taxation under Imperfect Competition," Working Papers, Queen's University, Department of Economics 821, Queen's University, Department of Economics.
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  17. Shrestha, Ratna K., 2001. "The choice of environmental policy instruments under correlated uncertainty," Resource and Energy Economics, Elsevier, Elsevier, vol. 23(2), pages 175-185, April.
  18. Susanne Dröge & Philipp Schröder, 2005. "How to Turn an Industry Green: Taxes versus Subsidies," Journal of Regulatory Economics, Springer, Springer, vol. 27(2), pages 177-202, November.
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