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Market Power and the Laffer Curve

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  • Miravete, Eugenio J
  • Seim, Katja
  • Thurk, Jeff

Abstract

We characterize the trade-off between consumption tax rates and tax revenue -- the Laffer curve -- while allowing for re-optimization by both consumers and firms with market power. Using detailed data from Pennsylvania, a state that monopolizes retail sales of alcoholic beverages, we estimate a discrete choice demand model allowing for flexible substitution patterns between products and across demographic groups while not imposing conduct among upstream distillers. We find that current policy overprices spirits and that firms respond to reductions in the state's ad valorem tax rate by increasing wholesale prices. The upstream response thus limits the state's revenue gain from lower tax rates to only 14% of the incremental tax revenue predicted under the common assumption of perfect competition. The burden of such naive policy falls disproportionately on older, poorer, uneducated, and minority consumers. Upstream collusion exacerbates these effects.

Suggested Citation

  • Miravete, Eugenio J & Seim, Katja & Thurk, Jeff, 2017. "Market Power and the Laffer Curve," CEPR Discussion Papers 12502, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:12502
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    Cited by:

    1. 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.
    2. Rachel Griffith & Martin O'Connell & Kate Smith, 2020. "Price floors and externality correction," IFS Working Papers W20/37, Institute for Fiscal Studies.
    3. 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.
    4. Matthew Grennan & Robert J. Town, 2020. "Regulating Innovation with Uncertain Quality: Information, Risk, and Access in Medical Devices," American Economic Review, American Economic Association, vol. 110(1), pages 120-161, January.
    5. Dearing, Adam, 2022. "Estimating structural demand and supply models using tax rates as instruments," Journal of Public Economics, Elsevier, vol. 205(C).
    6. Martin O'Connell & Kate Smith, 2021. "Optimal sin taxation and market power," IFS Working Papers W21/30, Institute for Fiscal Studies.
    7. 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.
    8. 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.
    9. Gehrsitz, Markus & Saffer, Henry & Grossman, Michael, 2021. "The effect of changes in alcohol tax differentials on alcohol consumption," Journal of Public Economics, Elsevier, vol. 204(C).
    10. Lin, Boqiang & Jia, Zhijie, 2019. "Tax rate, government revenue and economic performance: A perspective of Laffer curve," China Economic Review, Elsevier, vol. 56(C), pages 1-1.
    11. Keaton Miller & Boyoung Seo, 2021. "The Effect of Cannabis Legalization on Substance Demand and Tax Revenues," National Tax Journal, University of Chicago Press, vol. 74(1), pages 107-145.
    12. Gastón Illanes & Sarah Moshary, 2020. "Market Structure and Product Assortment: Evidence from a Natural Experiment in Liquor Licensure," NBER Working Papers 27016, National Bureau of Economic Research, Inc.
    13. Amit Gandhi & Jean-François Houde, 2019. "Measuring Substitution Patterns in Differentiated-Products Industries," NBER Working Papers 26375, National Bureau of Economic Research, Inc.
    14. Seungjin Han & Josip Lesica, 2021. "Differentiated Excise Taxation in the Beer Market," Department of Economics Working Papers 2021-10, McMaster University.
    15. Antoniou, Fabio & Fiocco, Raffaele, 2020. "Storable good market with intertemporal cost variations," MPRA Paper 97948, University Library of Munich, Germany.

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    More about this item

    Keywords

    Laffer Curve; market power; Public Monopoly Pricing; Tax Incidence;
    All these keywords.

    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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