The Efficiency of Indirect Taxes under Imperfect Competition

Journal of Public Economics (JPubE), August 2001, 231-251, with Simon Anderson and Andre de Palma

This paper considers the relative efficiency of ad valorem and unit taxes in imperfectly competitive markets. We provide
a simple proof that ad valorem taxes are welfare-superior to unit taxes in the short run when production costs are identical
across firms. The proof covers differentiated products and a wide range of market conduct. Cost asymmetries strengthen
the case for ad valorem taxation under Cournot competition, but unit taxation may be welfare-superior under Bertrand
competition with product differentiation. Ad valorem taxation is superior with free entry under Cournot competition, but
not necessarily under price competition when consumers value variety.