Unit taxes and ad valorem taxes with vertically differentiated products

Abstract

This article analyses a model in which a local monopolist that produces low-quality goods competes against a foreign competitive industry that produces a higher quality version of the goods. We use the model to analyse the welfare implications of introducing a unit tax on the local producer, relative to an ad valorem tax. We find parameter values for which the unit tax dominates the ad valorem tax, in the sense of increasing welfare while not reducing government revenues. This result contrasts with the mainstream results on the dominance of ad valorem over unit taxes.

Keywords:

• taxes
• monopoly
• vertical differentiation

JEL Classification:

• H21
• L13
• D60