Taxation, Revenue Sharing and Price Discrimination

We study the effects of taxes and fees in markets where sellers practice second-degree price discrimination, offering multiple versions of their product. Sellers distort the quantity (or quality) intended for all types of consumers, except for those with the highest marginal willingness to pay. We show that ad valorem taxes/fees can alleviate this distortion, thereby generating revenue while increasing consumer surplus and welfare, provided the tax rate increases with the size or quality of the version it applies to. We explore the implications of this result for important issues in fiscal policy (taxation of sin goods and of goods affecting labor supply). We also consider applications to the analysis of vertical relations between firms, as well as the strategy of platforms when setting prices for access and when competing with sellers.