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Market Power and the Laffer Curve

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  • Eugenio J. Miravete
  • Katja Seim
  • Jeff Thurk

Abstract

We study commodity taxation and characterize the Laffer curve, a trade‐off between tax rates and revenue, in noncompetitive markets. Pricing in these markets leads to incomplete tax pass‐through and agents re optimize their purchase and pricing decisions in response to any tax change. We use detailed data from Pennsylvania, a state that monopolizes retail sales of alcoholic beverages, to estimate a model of demand for horizontally differentiated products that ties consumers' demographic characteristics to heterogeneous preferences for spirits. We find that under the state's current tax policy, spirits are overpriced. Distillers respond to decreases in the tax rate by increasing wholesale prices, which limits the state's revenue gain to only 13% of the incremental tax revenue predicted under the common assumption of perfect competition. The strategic response of noncompetitive firms to changes in taxation therefore flattens the Laffer curve significantly.

Suggested Citation

  • Eugenio J. Miravete & Katja Seim & Jeff Thurk, 2018. "Market Power and the Laffer Curve," Econometrica, Econometric Society, vol. 86(5), pages 1651-1687, September.
    • Handle: RePEc:wly:emetrp:v:86:y:2018:i:5:p:1651-1687
    DOI: 10.3982/ECTA12307
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    3. Rachel Griffith & Martin O'Connell & Kate Smith, 2020. "Price floors and externality correction," IFS Working Papers W20/37, Institute for Fiscal Studies.
    4. Diwas KC & TI Tongil Kim & Jiayi Liu, 2022. "Electronic prescription monitoring and the opioid epidemic," Production and Operations Management, Production and Operations Management Society, vol. 31(11), pages 4057-4074, November.
    5. 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.
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    9. Dearing, Adam, 2022. "Estimating structural demand and supply models using tax rates as instruments," Journal of Public Economics, Elsevier, vol. 205(C).
    10. Henry Saffer & Markus Gehrsitz & Michael Grossman, 2022. "The Effects of Alcohol Excise Tax Increases by Drinking Level and by Income Level," NBER Working Papers 30097, National Bureau of Economic Research, Inc.
    11. Martin O'Connell & Kate Smith, 2021. "Optimal sin taxation and market power," IFS Working Papers W21/30, Institute for Fiscal Studies.
    12. Amir, Rabah & Jin, Jim Y. & Lasselle, Laurence, 2023. "Uniform, efficient and independent Ramsey taxes across markets," Games and Economic Behavior, Elsevier, vol. 138(C), pages 373-386.
    13. Øyvind Thomassen & Howard Smith & Stephan Seiler & Pasquale Schiraldi, 2017. "Multi-category Competition and Market Power: A Model of Supermarket Pricing," American Economic Review, American Economic Association, vol. 107(8), pages 2308-2351, August.
    14. Brett Hollenbeck & Kosuke Uetake, 2021. "Taxation and market power in the legal marijuana industry," RAND Journal of Economics, RAND Corporation, vol. 52(3), pages 559-595, September.
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    18. Adachi, Takanori & Fabinger, Michal, 2022. "Pass-through, welfare, and incidence under imperfect competition," Journal of Public Economics, Elsevier, vol. 211(C).
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    JEL classification:

    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies
    • L21 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Business Objectives of the Firm
    • L32 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Public Enterprises; Public-Private Enterprises

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