Competition and Welfare Effects of Differentiated Taxation: Evidence from the Irish Automobile Market

Anna Bennato, Franco Mariuzzo and  Patrick Paul Walsh (2018)

Centre for Competition Policy,  University of East Anglia,  Working paper 18-5.

Background

In recent years, policy makers in developed countries have adopted taxation systems that attempt to curb consumers’ behavior away from a harmful lifestyle such as a tax on sugar content.

Methodology

The papers develops a theoretical model to disentangle the effects on competition and welfare of the adoption of an ad valorem tax that varies according to product characteristics (quality) in an imperfectly competitive market. As an example of a market where taxation varies by product attributes, taxes increased with engines size, we use product-level yearly data on the Irish automobile market between 2004-2008 to explore the impact on competition and welfare of differentiated taxation by product characteristic.

Key findings

In the  Irish automobile market taxes increased with engines size but  did not lead to a significant shift in sales structure, as was its objective  Rather, it shifted profits and consumer surplus away from bigger and towards smaller engines, as a result of a tax-induced strategic change in the nature of short run price competition. Our analysis provides an understanding on the changes in short run price competition, sub-market sales and welfare structure, in a way that one can expect from taxing an environmentally unfriendly aspect of a product.  In the short-run, due to strategic price responses to the different levels of taxation, one sees dirty engines becoming cheaper and clean engines more expensive with no change in market share.  In the medium to long run, the tax structure may induce R&D that makes big engines clean pushing rents back up to big cars.  In the short run, the tax structure did not reduce harmful CO2 emissions in terms of global warming.

The Centre for Competition Policy (CCP), at the University of East Anglia, undertakes competition policy research, incorporating economic, legal, management and political science perspectives, that has real-world policy relevance without compromising academic rigour.

Full Paper and Policy brief attached.