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Corrective Tax Design and Market Power

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  • O'Connell, Martin
  • Smith, Kate

Abstract

We study the design of taxes aimed at limiting externalities in markets characterized by differentiated products and imperfect competition. In such settings policy must balance distortions from externalities with those associated with the exercise of market power; the optimal tax rate depends on the nature of external harms, how the degree of market power among externality generating products compares with non-taxed alternatives, and how consumers switch across these products. We apply the framework to taxation of sugar sweetened beverages. We use detailed data on the UK market for drinks to estimate consumer demand and oligopoly pricing for the differentiated products in the market. We show the welfare maximizing tax rate leads to welfare improvements over 2.5 times as large as that associated with policy that ignores distortions associated with the exercise of market power.

Suggested Citation

  • O'Connell, Martin & Smith, Kate, 2020. "Corrective Tax Design and Market Power," CEPR Discussion Papers 14582, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:14582
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    References listed on IDEAS

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    Cited by:

    1. 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.
    2. 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.
    3. 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).

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    More about this item

    Keywords

    corrective tax; externality; market power; oligopoly;
    All these keywords.

    JEL classification:

    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • 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
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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