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Market Power and the Laffer Curve
Author(s) -
Miravete Eugenio J.,
Seim Katja,
Thurk Jeff
Publication year - 2018
Publication title -
econometrica
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 16.7
H-Index - 199
eISSN - 1468-0262
pISSN - 0012-9682
DOI - 10.3982/ecta12307
Subject(s) - laffer curve , economics , power (physics) , keynesian economics , market power , econometrics , microeconomics , public economics , tax reform , physics , quantum mechanics , gross income , monopoly , state income tax
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.