Asymmetric Effects of Taxes on Product Market Outcomes
63 Pages Posted: 6 Jun 2022
Date Written: May 27, 2022
This paper examines whether taxes have a differential effect on the competitive position of profitable versus loss-making firms. Using granular data on prices and market share from the airline industry, we find that the 1986 Tax Reform Act (TRA) that cut the top corporate tax rate by 12 percentage points is followed by a 4.2% decrease in the relative ticket prices of profitable airlines compared to those of loss-making airlines, operating in the same route and period. Further, the tax cut is followed by a 3.3 percentage point increase in the market share of profitable airlines. The TRA leads to an increase in the number of profitable airlines entering new markets, especially those in which the incumbent is loss-making and financially constrained. In addition, tax-loss airlines, especially those that are financially constrained, are more likely to exit markets after the TRA. Evidence from staggered tax changes across U.S. states corroborates our main inferences from the TRA and airline setting. Our results are consistent with tax cuts facilitating product market predation, where profitable firms use the cash tax savings from tax cuts to gain market share from their financially constrained, loss-making competitors that do not experience immediate cash savings from tax cuts.
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