Optimal Indirect Taxation under Imperfect Competition
China Center for Economic Research
No. E2010016 November 9, 2010
Abstract: This paper considers a simple general equilibrium model of indirect taxation under imperfect competition. Tax revenue is viewed as the rent of government coercion power and gross profit is viewed as the rent of market power. A government maximizes consumer surplus conditional on a certain amount of rent being collected. In contrast with many models in the literature, this model assumes that the government and consumers make their decisions simultaneously, which means the government cannot commit to a tax structure through its “first-mover advantage”. It is found that when all commodities are taxable, the optimal indirect taxes should equalize the after-tax Lerner indexes of all commodities. When consumers’ labor supplies are sufficiently inelastic, the optimal taxes generally lead to social welfare gain rather than deadweight loss.
Keywords: Indirect tax, Deadweight loss, Excess burden, Imperfect competition, Lerner index
JEL classification: D59, H21, L16