Dajana Xhani, Tilburg School of Economics and Management

Seminar

Date: Tuesday 18 October 2022

Time: 13.00 – 14.30

Location: IIES Seminar Room A822/Zoom

Title: Correcting Market Power with Taxation: A Sufficient Statistic Approach

Correcting Market Power with Taxation: A Sufficient Statistic Approach

This paper investigates the potential for tax policy to reduce distortions caused by market power. I provide a novel non-parametric approach that does not rest on strong assumptions about demand curves while simultaneously accounting for general equilibrium effects. To that end, I derive the welfare incidence of general shocks in models of monopolistic competition and heterogenous firms. I decompose the welfare effect into three channels: (i) the direct effect of the shock, (ii) a selection effect that arises on the extensive margin and, (iii) a reallocation effect as production shifts across firms. The latter depends on the joint distribution of firm-level markups, output responsiveness and sales. I show that it is possible to recover output responsiveness non-parametrically from revenue and cost data when the production function is homogenous in variable inputs. I apply this method to a large dataset of UK firms and find that at the industry level markups are decreasing with firm size while output responsiveness is increasing. Finally, I use these results to empirically evaluate a tax reform aimed at reducing misallocation. I estimate that a simple two-tier VAT tax change that increases the VAT rate from 20% to 24% for firms with sales larger than £2m and uses the proceeds to fund a cut for smaller firms improves aggregate utility by 2%. 

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