Lapan, Harvey E.; Hennessy, David A.

Journal of Public Economic Theory Vol. 13 no. 1 (February 2011): 125-138. (Originally published as WP #07007, April 2007 (Revised on August 13, 2009))

The welfare dominance of ad valorem taxes over unit taxes in a single-market Cournot oligopoly is well-known. This article extends the analysis to multi-market oligopoly. Provided all ad valorem taxes are positive, unit costs are constant, firms are active in all considered markets, and a representative consumer has convex preferences, it is shown that ad valorem taxes dominate in multi-product equilibrium. We discuss the role of unit cost covariances across multi-product firms in determining the extent of cost efficiencies arising under ad valorem taxation. The issue of merger under oligopoly is also considered. Conditions are identified under which a merger increases the sum of consumer and producer surpluses while also increasing the revenue yield from a set of unit taxes. If not all firms are active in all considered markets, then it is also shown that additional conditions are required to ensure the dominance of ad valorem taxes. In multi-input Cournot oligopsony, however, unit taxation welfare dominates. This is because ad valorem taxes on inputs reduce demand elasticities, amplifying market power distortions.

JEL Classification: D43, H21

Keywords: ad valorem tax, imperfect competition, oligopoly merger, quantity-setting game, specific tax, tax efficiency, tax revenue

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