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Ad valorem versus unit taxes: Monopolistic competition, heterogeneous firms, and intra-industry reallocations

Philipp Schröder and Allan Sørensen ()

Economics Working Papers from Department of Economics and Business Economics, Aarhus University

Abstract: Real-world industries are composed from heterogeneous firms and substantial intra-industry reallocations take place, i.e. high productivity firms squeeze out low productivity firms. Previous tax-tool comparisons have not included these central forces of industry structure. This paper examines a general equilibrium monopolistic competition model with heterogeneous firms and intra-industry reallocations. We show that the welfare superiority of ad valorem over unit taxes under imperfect competition is not only preserved but amplified. The additional difference between the tools arises because unit taxes distort relative prices, which in turn reduces average industry productivity through reallocations (the survival and increased market share of lower productivity firms). Importantly, numerical solutions of the model reveal that the relative welfare loss from using the unit tax increases dramatically in the degree of firm heterogeneity.

Keywords: unit tax; ad valorem tax; welfare; intra-industry reallocation; monopolistic competition; heterogenous firms (search for similar items in EconPapers)
JEL-codes: D43 D61 H21 H22 H23 L11 L13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mic and nep-pub
Date: 2010-06-23
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Journal Article: Ad valorem versus unit taxes: monopolistic competition, heterogeneous firms, and intra-industry reallocations (2010) Downloads
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