Discrete Prices and the Incidence and Efficiency of Excise Taxes

Abstract

This paper uses UPC-level data to examine the relationship between excise taxes, retail prices, and consumer welfare in the distilled spirits market. We document a nominal rigidity in retail prices that arises because firms largely choose prices that end in ninety-nine cents and change prices in whole-dollar increments. A correctly specified model, like an ordered logit, takes this discreteness into account when predicting the effects of alternative taxes. Explicitly accounting for price points substantially impacts estimates of tax incidence and the excess burden cost of tax revenue. Meaningful non-monotonicities in these quantities expand the potential considerations in setting excise taxes.

Keywords: Excise Tax, Incidence, Market Power, Price Adjustment, Nominal Rigidities

JEL Classification: H21, H22, H71