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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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    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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