Market Structure, the Functional Form of Demand and the Sensitivity of the Vertical Reaction Function

IEB Working Paper N. 2015/28

26 Pages Posted: 26 Oct 2015

See all articles by Agustin Redonda

Agustin Redonda

Council on Economic Policies (CEP)

Date Written: October 22, 2015

Abstract

Tax incidence and tax competition have largely been studied separately. Models assessing the incidence of excise taxes do not consider strategic interaction and exclusively assess the pass-through of taxes to prices. These settings focus on imperfectly competitive markets where prices can react more (less) than proportionally to a variation in tax rates. On the other hand, tax competition models focus on the strategic interactions arising because of a shared tax base but assume producer prices to be constant. Hence, the pass-through of taxes is restricted to be fully on consumers. This paper extends Keen (1997) by relaxing this assumption and, thus, by allowing local governments to internalize the possibility that taxes are over-shifted (undershifted). Interestingly, market structure (that was absent in previous settings), turns out to be one of the determinants of the vertical reaction function in this model; particularly determining the sensitivity of local tax setters to a variation of higher-tier taxes.

Keywords: Vertical tax competition, pass-through, market structure, excise taxes, tax incidence

JEL Classification: H22, H70, D43, L13

Suggested Citation

Redonda, Agustin, Market Structure, the Functional Form of Demand and the Sensitivity of the Vertical Reaction Function (October 22, 2015). IEB Working Paper N. 2015/28, Available at SSRN: https://ssrn.com/abstract=2680271 or http://dx.doi.org/10.2139/ssrn.2680271

Agustin Redonda (Contact Author)

Council on Economic Policies (CEP) ( email )

Z├╝rich, 8008
Switzerland

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