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Title: Market Power and the Laffer Curve

Author(s): Eugenio J Miravete, Katja Seim and Jeff Thurk

Publication Date: December 2017

Keyword(s): Laffer Curve, market power, Public Monopoly Pricing and Tax Incidence

Programme Area(s): Industrial Organization

Abstract: We characterize the trade-off between consumption tax rates and tax revenue -- the Laffer curve -- while allowing for re-optimization by both consumers and firms with market power. Using detailed data from Pennsylvania, a state that monopolizes retail sales of alcoholic beverages, we estimate a discrete choice demand model allowing for flexible substitution patterns between products and across demographic groups while not imposing conduct among upstream distillers. We find that current policy overprices spirits and that firms respond to reductions in the state's ad valorem tax rate by increasing wholesale prices. The upstream response thus limits the state's revenue gain from lower tax rates to only 14% of the incremental tax revenue predicted under the common assumption of perfect competition. The burden of such naive policy falls disproportionately on older, poorer, uneducated, and minority consumers. Upstream collusion exacerbates these effects.

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Bibliographic Reference

Miravete, E, Seim, K and Thurk, J. 2017. 'Market Power and the Laffer Curve'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=12502