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Excise taxes, over-shifting, cross-elasticity, and tax revenue

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Abstract

This article examines cross-elasticity effects in excise taxation for markets characterized by monopolistic competition and over-shifting. Extending the constant elasticity demand model to consider cross-elasticity leads to notably different results regarding tax revenue maximization. With nonzero but weak cross-elasticity effects relative to the price elasticity, we derive a higher optimal tax-price ratio compared to prior research. With strong cross-elasticity, revenue can continually be increased by raising the excise tax. Overall, the study offers government greater incentive to use excise taxes to obtain revenue.

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... Under this scenario, the retail price increase is less than the tax increase, suggesting a tax pass-through rate that is less than one. In other scenarios, taxes may be over-shifted, exact-shifted, or under-shifted to prices [5][6][7][8]. For example, manufacturers may have incentives to raise prices at higher levels than the amount of tax hikes to compensate for profit and revenue loss, leading to a tax pass-through rate greater than one, as in the case of the cigarette market [9][10][11][12][13]. ...
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... Specifically, several scenarios may lead to overshifting of taxes to prices, such as a convex demand curve or a constant marginal cost compounded with an elastic demand. (Young and Bielińska-Kwapisz 2002, Dutkowsky and Sullivan 2014, Dutkowsky and Sullivan 2017, Tremblay and Tremblay 2017 Manufacturers also have incentives to raise prices more than the amount of tax hikes to compensate for profit and revenue loss, if they have the market power to do so. (Fullerton andMetcalf 2002, Shrestha andMarkowitz 2016) Nonetheless, how taxes are passed to prices is an empirical question and has been extensively studied in the form of tax pass-through rates to prices. ...
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ABSTRACT On October 1, 2002 the State of Alaska increased taxes on malt beverages from $0.35 per gallon to $1.07 per gallon; increased taxes on wine from $0.85 per gallon to $2.50 per gallon; and increased taxes on distilled spirits from $5.60 per gallon to $12.50 per gallon. We use primary data on alcoholic beverage prices in Alaska to study a very basic question: What was the impact of the tax hikes on prices? Economic theory and previous empirical studies, mainly of taxes on goods other than alcoholic beverages, do not provide very much guidance on what to expect. For competitive markets with constant marginal costs of production, taxes are predicted to be fully passed through to prices, but in imperfectly competitive markets a 1-cent increase in taxes may increase taxes by less than or more than 1-cent. To address this very basic empirical question, just before and a year after the tax hike we conducted telephone surveys of on-premise and off-premise alcohol retail establishments across Alaska. The rich data allow us to estimate the impact of the tax hike: across beverage types (beer, wine, spirits); across brands; and across premise type. 1
Excise Taxes, Consumer Demand, Over-Shifting, and Tax Revenue
  • D Dutkowsky
  • R Sullivan