Asymmetric Effects of Taxes on Product Market Outcomes

63 Pages Posted: 6 Jun 2022

See all articles by Michelle Hanlon

Michelle Hanlon

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Nemit Shroff

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Rachel Yoon

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: May 27, 2022

Abstract

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.

Suggested Citation

Hanlon, Michelle and Shroff, Nemit and Yoon, Rachel, Asymmetric Effects of Taxes on Product Market Outcomes (May 27, 2022). Available at SSRN: https://ssrn.com/abstract=4121571 or http://dx.doi.org/10.2139/ssrn.4121571

Michelle Hanlon

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Nemit Shroff (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=51407&co_list=F

Rachel Yoon

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

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