Optimal Commodity Taxation with Tax Brackets Under Vertical Product Differentiation
In this paper, we analyze the effects of commodity taxation with tax brackets under a vertically differentiated multiproduct monopoly and show an optimal taxation scheme. The tax brackets are classified by product qualities. A monopolist with two products determines the prices and qualities of the products that will maximize his profit, given the tax brackets. Based on this monopolistic behavior, the government determines taxation using tax brackets that will maximize social welfare (SW). In such a taxation plan, because there may be notches at different tax thresholds, by analyzing the effects of the notches on SW, we are able to show whether setting notches can improve SW. Our results are as follows. The optimal taxation plan levies a tax on the low-quality side of the tax bracket and grants a subsidy on the high-quality side of the bracket. On the high-quality side of the bracket, the subsidy helps give incentives to the monopolist to improve product qualities. On the other hand, on the low-quality side of the bracket, the tax levied helps reduce the monopolist’s incentive to position on the low-quality side of the bracket, that is, it induces the monopolist to position the product on the high-quality side of the bracket. Furthermore, the government can induce the monopolist to improve product qualities by raising the tax threshold and binding the low-quality product to the threshold. That is, the government can improve SW by inducing two products to locate on the high-quality side of the bracket to improve their quality.
This research is supported by a Grant-in-Aid for Scientific Research (15K03453) from the Japan Society for the Promotion of Science.
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