The efficiency of indirect taxes under imperfect competition

This paper considers the relative efficiency of ad valorem and unit taxes in imperfectly competitive markets. We provide a simple proof that ad valorem taxes are welfare-superior to unit taxes in the short run when production costs are identical across firms. The proof covers differentiated products and a wide range of market conduct. Cost asymmetries strengthen the case for ad valorem taxation under Cournot competition, but unit taxation may be welfare-superior under Bertrand competition with product differentiation. Ad valorem taxation is superior with free entry under Cournot competition, but not necessarily under price competition when consumers value variety. (C) 2001 Elsevier Science B.V. All rights reserved.