IDEAS home Printed from https://ideas.repec.org/a/aea/aejapp/v16y2024i4p34-70.html
   My bibliography  Save this article

Optimal Sin Taxation and Market Power

Author

Listed:
  • Martin O'Connell
  • Kate Smith

Abstract

We study how market power impacts the efficiency and redistributive properties of sin taxation, with an empirical application to sugar-sweetened beverage taxation. We estimate an equilibrium model of the UK drinks market, which we embed in a tax design framework to solve for optimal sugar-sweetened beverage tax policy. Positive price-cost margins for drinks create inefficiencies that lower the optimal rate compared with a perfectly competitive setting. Since profits mainly accrue to the rich, this is partially mitigated under social preferences for equity. Overall, ignoring market power when setting tax policy leads to welfare gains 40 percent below those at the optimum.

Suggested Citation

  • Martin O'Connell & Kate Smith, 2024. "Optimal Sin Taxation and Market Power," American Economic Journal: Applied Economics, American Economic Association, vol. 16(4), pages 34-70, October.
    • Handle: RePEc:aea:aejapp:v:16:y:2024:i:4:p:34-70
    DOI: 10.1257/app.20220407
    as

    Download full text from publisher

    File URL: https://www.aeaweb.org/doi/10.1257/app.20220407
    Download Restriction: no
    File URL: https://doi.org/10.3886/E183642V1
    Download Restriction: no
    File URL: https://www.aeaweb.org/doi/10.1257/app.20220407.appx
    Download Restriction: no
    File URL: https://www.aeaweb.org/doi/10.1257/app.20220407.ds
    Download Restriction: Access to full text is restricted to AEA members and institutional subscribers.
    File URL: https://libkey.io/10.1257/app.20220407?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Justine S. Hastings, 2004. "Vertical Relationships and Competition in Retail Gasoline Markets: Empirical Evidence from Contract Changes in Southern California," American Economic Review, American Economic Association, vol. 94(1), pages 317-328, March.
    2. Thomas Piketty & Emmanuel Saez & Gabriel Zucman, 2018. "Distributional National Accounts: Methods and Estimates for the United States," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 133(2), pages 553-609.
    3. Raj Chetty, 2009. "Sufficient Statistics for Welfare Analysis: A Bridge Between Structural and Reduced-Form Methods," Annual Review of Economics, Annual Reviews, vol. 1(1), pages 451-488, May.
    4. Steven T. Berry & Philip A. Haile, 2020. "Nonparametric Identification of Differentiated Products Demand Using Micro Data," NBER Working Papers 27704, National Bureau of Economic Research, Inc.
    5. J. Levin & L. Einav, 2012. "Empirical Industrial Organization: A Progress Report," Voprosy Ekonomiki, NP Voprosy Ekonomiki, issue 1.
    6. Pierre Dubois & Rachel Griffith & Martin O'Connell, 2020. "How Well Targeted Are Soda Taxes?," American Economic Review, American Economic Association, vol. 110(11), pages 3661-3704, November.
    7. Céline Bonnet & Pierre Dubois, 2010. "Inference on vertical contracts between manufacturers and retailers allowing for nonlinear pricing and resale price maintenance," RAND Journal of Economics, RAND Corporation, vol. 41(1), pages 139-164, March.
    8. Eugenio J. Miravete & Katja Seim & Jeff Thurk, 2020. "One Markup to Rule Them All: Taxation by Liquor Pricing Regulation," American Economic Journal: Microeconomics, American Economic Association, vol. 12(1), pages 1-41, February.
    9. Kopczuk, Wojciech, 2003. "A note on optimal taxation in the presence of externalities," Economics Letters, Elsevier, vol. 80(1), pages 81-86, July.
    10. Jan De Loecker & Jan Eeckhout & Gabriel Unger, 2020. "The Rise of Market Power and the Macroeconomic Implications [“Econometric Tools for Analyzing Market Outcomes”]," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 135(2), pages 561-644.
    11. Nathaniel Hendren, 2016. "The Policy Elasticity," Tax Policy and the Economy, University of Chicago Press, vol. 30(1), pages 51-89.
    12. Emmanuel Saez & Joel Slemrod & Seth H. Giertz, 2012. "The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 50(1), pages 3-50, March.
    13. Igal Hendel & Aviv Nevo, 2006. "Measuring the Implications of Sales and Consumer Inventory Behavior," Econometrica, Econometric Society, vol. 74(6), pages 1637-1673, November.
    14. Griffith, Rachel & O’Connell, Martin & Smith, Kate, 2019. "Tax design in the alcohol market," Journal of Public Economics, Elsevier, vol. 172(C), pages 20-35.
    15. Harding, Matthew & Lovenheim, Michael, 2017. "The effect of prices on nutrition: Comparing the impact of product- and nutrient-specific taxes," Journal of Health Economics, Elsevier, vol. 53(C), pages 53-71.
    16. James B. Bushnell & Erin T. Mansur & Celeste Saravia, 2008. "Vertical Arrangements, Market Structure, and Competition: An Analysis of Restructured US Electricity Markets," American Economic Review, American Economic Association, vol. 98(1), pages 237-266, March.
    17. Igal Hendel & Aviv Nevo, 2006. "Sales and consumer inventory," RAND Journal of Economics, RAND Corporation, vol. 37(3), pages 543-561, September.
    18. John Cawley & David Frisvold & Anna Hill & David Jones, 2020. "The Impact of the Philadelphia Beverage Tax on Prices and Product Availability," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 39(3), pages 605-628, June.
    19. Villas-Boas, Sofia B., 2006. "Vertical relationships between manufacturers and retailers: inference with limited data," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt0z26d2v9, Department of Agricultural & Resource Economics, UC Berkeley.
    20. Emmanuel Saez, 2002. "Optimal Income Transfer Programs: Intensive versus Extensive Labor Supply Responses," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(3), pages 1039-1073.
    21. E. Glen Weyl & Michal Fabinger, 2013. "Pass-Through as an Economic Tool: Principles of Incidence under Imperfect Competition," Journal of Political Economy, University of Chicago Press, vol. 121(3), pages 528-583.
    22. Cawley, John & Meyerhoefer, Chad, 2012. "The medical care costs of obesity: An instrumental variables approach," Journal of Health Economics, Elsevier, vol. 31(1), pages 219-230.
    23. Nevo, Aviv, 2001. "Measuring Market Power in the Ready-to-Eat Cereal Industry," Econometrica, Econometric Society, vol. 69(2), pages 307-342, March.
    24. Rachel Griffith & Lars Nesheim & Martin O'Connell, 2018. "Income effects and the welfare consequences of tax in differentiated product oligopoly," Quantitative Economics, Econometric Society, vol. 9(1), pages 305-341, March.
    25. Maria Polyakova & Stephen P. Ryan, 2019. "Subsidy Targeting with Market Power," NBER Working Papers 26367, National Bureau of Economic Research, Inc.
    26. Bresnahan, Timothy F., 1989. "Empirical studies of industries with market power," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 2, chapter 17, pages 1011-1057, Elsevier.
    27. Buchanan, James M, 1969. "External Diseconomies, Corrective Taxes, and Market Structure," American Economic Review, American Economic Association, vol. 59(1), pages 174-177, March.
    28. Matthew Smith & Owen Zidar & Eric Zwick, 2020. "Top Wealth in America: New Estimates and Implications for Taxing the Rich," Working Papers 264, Princeton University, Department of Economics, Center for Economic Policy Studies..
    29. Villas-Boas, Sofia B., 2007. "Vertical relationships between manufacturers and retailers: inference with limited data," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt6gz1t778, Department of Agricultural & Resource Economics, UC Berkeley.
    30. Pierre Dubois & Rachel Griffith & Martin O’Connell, 2018. "The Effects of Banning Advertising in Junk Food Markets," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 85(1), pages 396-436.
    31. Eugenio J. Miravete & Katja Seim & Jeff Thurk, 2018. "Market Power and the Laffer Curve," Econometrica, Econometric Society, vol. 86(5), pages 1651-1687, September.
    32. W. M. Gorman, 1980. "A Possible Procedure for Analysing Quality Differentials in the Egg Market," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 47(5), pages 843-856.
    33. Sofia Berto Villas-Boas, 2007. "Vertical Relationships between Manufacturers and Retailers: Inference with Limited Data," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 74(2), pages 625-652.
    34. Emmanuel Saez & Gabriel Zucman, 2016. "Editor's Choice Wealth Inequality in the United States since 1913: Evidence from Capitalized Income Tax Data," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 131(2), pages 519-578.
    35. M Arantxa Colchero & Juan Carlos Salgado & Mishel Unar-Munguía & Mariana Molina & Shuwen Ng & Juan Angel Rivera-Dommarco, 2015. "Changes in Prices After an Excise Tax to Sweetened Sugar Beverages Was Implemented in Mexico: Evidence from Urban Areas," PLOS ONE, Public Library of Science, vol. 10(12), pages 1-11, December.
    36. Michael Cooper & John McClelland & James Pearce & Richard Prisinzano & Joseph Sullivan & Danny Yagan & Owen Zidar & Eric Zwick, 2016. "Business in the United States: Who Owns It, and How Much Tax Do They Pay?," Tax Policy and the Economy, University of Chicago Press, vol. 30(1), pages 91-128.
    37. Jan De Loecker & Jan Eeckhout, 2018. "Global Market Power," NBER Working Papers 24768, National Bureau of Economic Research, Inc.
    38. Sharat Ganapati & Joseph S. Shapiro & Reed Walker, 2020. "Energy Cost Pass-Through in US Manufacturing: Estimates and Implications for Carbon Taxes," American Economic Journal: Applied Economics, American Economic Association, vol. 12(2), pages 303-342, April.
    39. Facundo Alvaredo & Lucas Chancel & Thomas Piketty & Gabriel Zucman, 2018. "Distributional National Accounts," Post-Print halshs-03342488, HAL.
    40. Henrik Kleven, 2020. "Sufficient Statistics Revisited," NBER Working Papers 27242, National Bureau of Economic Research, Inc.
    41. Igal Hendel & Aviv Nevo, 2013. "Intertemporal Price Discrimination in Storable Goods Markets," American Economic Review, American Economic Association, vol. 103(7), pages 2722-2751, December.
    42. Victor Chernozhukov & Jerry Hausman & Whitney K. Newey, 2019. "Demand analysis with many prices," CeMMAP working papers CWP59/19, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.
    43. Peter A. Diamond, 1973. "Consumption Externalities and Imperfect Corrective Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(2), pages 526-538, Autumn.
    44. Browning, M J, 1983. "Necessary and Sufficient Conditions for Conditional Cost Functions," Econometrica, Econometric Society, vol. 51(3), pages 851-856, May.
    45. Jeffrey Grogger, 2017. "Soda Taxes And The Prices of Sodas And Other Drinks: Evidence From Mexico," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 99(2), pages 481-498.
    46. Hunt Allcott & Benjamin B Lockwood & Dmitry Taubinsky, 2019. "Regressive Sin Taxes, with an Application to the Optimal Soda Tax," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 134(3), pages 1557-1626.
    47. Berry, Steven & Levinsohn, James & Pakes, Ariel, 1995. "Automobile Prices in Market Equilibrium," Econometrica, Econometric Society, vol. 63(4), pages 841-890, July.
    48. Igal Hendel & Aviv Nevo, 2006. "Sales and Consumer Inventory," RAND Journal of Economics, The RAND Corporation, vol. 37(3), pages 543-561, Autumn.
    49. Mark R. Jacobsen & Christopher R. Knittel & James M. Sallee & Arthur A. van Benthem, 2020. "The Use of Regression Statistics to Analyze Imperfect Pricing Policies," Journal of Political Economy, University of Chicago Press, vol. 128(5), pages 1826-1876.
    50. Daniel McFadden & Kenneth Train, 2000. "Mixed MNL models for discrete response," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(5), pages 447-470.
    51. Steven T. Berry, 1994. "Estimating Discrete-Choice Models of Product Differentiation," RAND Journal of Economics, The RAND Corporation, vol. 25(2), pages 242-262, Summer.
    52. Meredith Fowlie & Mar Reguant & Stephen P. Ryan, 2016. "Market-Based Emissions Regulation and Industry Dynamics," Journal of Political Economy, University of Chicago Press, vol. 124(1), pages 249-302.
    53. Emily Yucai Wang, 2015. "The impact of soda taxes on consumer welfare: implications of storability and taste heterogeneity," RAND Journal of Economics, RAND Corporation, vol. 46(2), pages 409-441, June.
    54. Aviv Nevo & Catherine Wolfram, 2002. "Why Do Manufacturers Issue Coupons? An Empirical Analysis of Breakfast Cereals," RAND Journal of Economics, The RAND Corporation, vol. 33(2), pages 319-339, Summer.
    55. Chad Syverson, 2019. "Macroeconomics and Market Power: Context, Implications, and Open Questions," Journal of Economic Perspectives, American Economic Association, vol. 33(3), pages 23-43, Summer.
    56. Pietro Tebaldi, 2022. "Estimating Equilibrium in Health Insurance Exchanges: Price Competition and Subsidy Design under the ACA," NBER Working Papers 29869, National Bureau of Economic Research, Inc.
    57. Bonnet, Céline & Réquillart, Vincent, 2013. "Tax incidence with strategic firms in the soft drink market," Journal of Public Economics, Elsevier, vol. 106(C), pages 77-88.
    58. Browning, Martin & Meghir, Costas, 1991. "The Effects of Male and Female Labor Supply on Commodity Demands," Econometrica, Econometric Society, vol. 59(4), pages 925-951, July.
    59. By Louis Kaplow, 2012. "Optimal Control Of Externalities In The Presence Of Income Taxation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 53(2), pages 487-509, May.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Goncalves, Judite & Merenda, Roxanne & dos Santos, João Pereira, 2022. "Not so sweet: The impact of the Portuguese soda tax on producers," Ruhr Economic Papers 938, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    2. Rosella Levaggi & Carmen Marchiori & Paolo M. Panteghini, 2022. "Lifestyle taxes in the presence of profit shifting," Journal of Economics, Springer, vol. 137(1), pages 81-96, September.
    3. Judite Gonçalves & Roxanne Merenda & João Pereira dos Santos, 2024. "Not so sweet: impacts of a soda tax on producers," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 31(5), pages 1388-1412, October.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. O'Connell, Martin & Smith, Kate, 2020. "Corrective Tax Design and Market Power," CEPR Discussion Papers 14582, C.E.P.R. Discussion Papers.
    2. Pierre Dubois & Rachel Griffith & Martin O'Connell, 2020. "How Well Targeted Are Soda Taxes?," American Economic Review, American Economic Association, vol. 110(11), pages 3661-3704, November.
    3. Martin O'Connell & Pierre Dubois & Rachel Griffith, 2022. "The Use of Scanner Data for Economics Research," Annual Review of Economics, Annual Reviews, vol. 14(1), pages 723-745, August.
    4. Abi-Rafeh, Rossi & Dubois, Pierre & Griffith, Rachel & O'Connell, Martin, 2023. "The Effects of Sin Taxes and Advertising Restrictions in a Dynamic Equilibrium," CEPR Discussion Papers 18527, C.E.P.R. Discussion Papers.
    5. Eugenio J. Miravete & Katja Seim & Jeff Thurk, 2018. "Market Power and the Laffer Curve," Econometrica, Econometric Society, vol. 86(5), pages 1651-1687, September.
    6. Griffith, Rachel & O’Connell, Martin & Smith, Kate, 2019. "Tax design in the alcohol market," Journal of Public Economics, Elsevier, vol. 172(C), pages 20-35.
    7. SERSE Valerio,, 2019. "Do sugar taxes affect the right consumers ?," LIDAM Discussion Papers CORE 2019017, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    8. Eugenio J. Miravete & Katja Seim & Jeff Thurk, 2020. "One Markup to Rule Them All: Taxation by Liquor Pricing Regulation," American Economic Journal: Microeconomics, American Economic Association, vol. 12(1), pages 1-41, February.
    9. Allais, Olivier & Etilé, Fabrice & Lecocq, Sébastien, 2015. "Mandatory labels, taxes and market forces: An empirical evaluation of fat policies," Journal of Health Economics, Elsevier, vol. 43(C), pages 27-44.
    10. Rachel Griffith & Martin O’Connell & Kate Smith, 2022. "Price Floors and Externality Correction," The Economic Journal, Royal Economic Society, vol. 132(646), pages 2273-2289.
    11. Victor Aguirregabiria & Margaret Slade, 2017. "Empirical models of firms and industries," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 50(5), pages 1445-1488, December.
    12. Wang, Ao, 2021. "A BLP Demand Model of Product-Level Market Shares with Complementarity," The Warwick Economics Research Paper Series (TWERPS) 1351, University of Warwick, Department of Economics.
    13. Matthew Backus & Christopher Conlon & Michael Sinkinson, 2021. "Common Ownership and Competition in the Ready-to-Eat Cereal Industry," NBER Working Papers 28350, National Bureau of Economic Research, Inc.
    14. Ellalee, Haider & Alali, Walid Y., 2022. "A Welfare and Pass-Through Effects of Regulations within Imperfect Competition," MPRA Paper 116512, University Library of Munich, Germany.
    15. Pinelopi Koujianou Goldberg & Rebecca Hellerstein, 2006. "A Framework for Identifying the Sources of Local-Currency Price Stability with an Empirical Application," 2006 Meeting Papers 625, Society for Economic Dynamics.
    16. Charles J. Romeo, 2016. "Incorporating Prior Information into A GMM Objective For Mixed Logit Demand Systems," Journal of Industrial Economics, Wiley Blackwell, vol. 64(2), pages 336-363, June.
    17. Wang, Ao, 2023. "Sieve BLP: A semi-nonparametric model of demand for differentiated products," Journal of Econometrics, Elsevier, vol. 235(2), pages 325-351.
    18. Bonnet, Céline & Richards, Timothy J., 2016. "Models of Consumer Demand for Differentiated Products," TSE Working Papers 16-741, Toulouse School of Economics (TSE).
    19. Hellerstein, Rebecca & Villas-Boas, Sofia B., 2010. "Outsourcing and pass-through," Journal of International Economics, Elsevier, vol. 81(2), pages 170-183, July.
    20. Vincent R. Nijs & Kanishka Misra & Karsten Hansen, 2014. "Outsourcing Retail Pricing to a Category Captain: The Role of Information Firewalls," Marketing Science, INFORMS, vol. 33(1), pages 66-81, January.

    More about this item

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
    • L66 - Industrial Organization - - Industry Studies: Manufacturing - - - Food; Beverages; Cosmetics; Tobacco

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:aea:aejapp:v:16:y:2024:i:4:p:34-70. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Michael P. Albert (email available below). General contact details of provider: https://edirc.repec.org/data/aeaaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.