Efficiency and Incidence of Taxation with Free Entry and Love-of-Variety Preferences

44 Pages Posted: 24 May 2021 Last revised: 18 Apr 2022

See all articles by Kory Kroft

Kory Kroft

University of Toronto

Jean-William Laliberté

University of Calgary - Department of Economics

rlealv@banxico.org.mx Leal Vizcaíno

Bank of Mexico

Matthew Notowidigdo

University of Chicago - Booth School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: May 2021

Abstract

This paper develops a theory of commodity taxation with love-of-variety preferences and endogenous firm entry and exit. We consider a framework that encompasses a wide range of firm conduct and derive formulas for efficiency and pass-through of specific and ad valorem taxes. These formulas unify existing canonical ones in the literature and lead to novel economic insights for both welfare and incidence. We use them to derive a desirability condition for when ad valorem taxation is more efficient than specific taxation and a condition for when ad valorem taxation leads to greater pass-through than specific taxation. Finally, we consider an empirical application that illustrates how to estimate the key parameters of the tax formulas in a theoretically consistent way. Our results indicate that specific taxes are more efficient at the margin than ad valorem taxes and that product variety is below the socially optimal level.

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Suggested Citation

Kroft, Kory and P. Laliberté, Jean-William and Leal Vizcaíno, rlealv@banxico.org.mx and Notowidigdo, Matthew, Efficiency and Incidence of Taxation with Free Entry and Love-of-Variety Preferences (May 2021). NBER Working Paper No. w28838, Available at SSRN: https://ssrn.com/abstract=3851841

Kory Kroft (Contact Author)

University of Toronto ( email )

Toronto, Ontario M5S 3G8
Canada

Jean-William P. Laliberté

University of Calgary - Department of Economics ( email )

2500 University Dr. N.W.
Calgary, Albetra T2N 1N4
Canada

Matthew Notowidigdo

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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