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MARKET POWER AND THE LAFFER CURVE
(Click above to download a pdf copy of the paper)
  • 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.

  • Co-authors: Katja Seim (Wharton) and Jeff Thurk (Notre Dame).

  • Publication: Previously circulated as CEPR DP No. 9641.

  • JEL: L10, L21, L32.

  • First version: February 2014.

  • Current version: September 2017.

  • Seminars: Cornell, Indiana, Maryland, Northwestern, Oklahoma, U.S. Department of Justice.

  • Conferences: None.

  • Presentations: PDF.

  • Media Citations: None yet.