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Corrective Ad Valorem and Unit Taxes: A Welfare Comparison

Susanne Dröge and Philipp Schröder

No 534, Discussion Papers of DIW Berlin from DIW Berlin, German Institute for Economic Research

Abstract: The ad valorem versus unit taxes debate has traditionally emphasized tax yield. For this criterion, ad valorem taxes outperform unit taxes in terms of welfare for a wide range of imperfect competition settings, including Dixit-Stiglitz monopolistic competition. Yet, in a number of policy fields, such as environmental, health or trade economics, policy makers apply taxes to target the production/consumption volume in an industry, i.e. aim at a certain corrective effect rather than tax yield. This paper compares the two tax instruments with respect to equal corrective-effect in a Dixit-Stiglitz setting with love of variety, entry, exit, and redistribution of tax revenues. We find that unit taxes lead to more firms in the industry, less output per firm, less tax revenue, but higher welfare compared to ad valorem taxes.

Keywords: Externalities; Monopolistic competition; Taxes; Specific taxes; Welfare (search for similar items in EconPapers)
JEL-codes: H23 L13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-pbe and nep-pub
Date: 2005
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