In Market Power and the Laffer Curve, we characterize the trade-off between commodity tax rates (x-axis) and tax revenue (y-axis) -- the Laffer curve -- while allowing for re-optimization by both consumers and firms. We show that firms with market power respond to an increase (decrease) in the tax rate by decreasing (increasing) their prices. This flattens and shifts the Laffer curve to the right ("Firm Response" in the figure). The implications are significant -- limiting government to attain only 13% of the incremental tax revenue predicted under the common assumption of perfect competition. Upstream collusion exacerbates these effects. While our empirical application pertains to consumer goods taxation, the underlying mechanism (the strategic price response of firms to changes in tax policy) is also relevant for capital goods markets.
We conclude that effective tax policy must account for the behavioral response of not just consumers but also firms -- a theoretical point made by Musgrave (1959), Bishop (1968), Buchanan (1969), and Atkinson & Stiglitz (1980, 2015) but ignored in the existing public economics literature. Our work highlights the empirical relevance of their conclusions since perfectly competitive markets are rare in practice.
I am an Assistant Professor of economics at the University of Notre Dame. My research addresses the pricing and innovation decisions of firms, particularly in relation to changes in government tax, trade, and innovation policy. I do so by combining detailed data with economic models to answer important economic questions with an eye towards better understanding firm incentives and ultimately the impact on consumers. Using this approach, I am able to make empirical contributions to long-standing questions in the fields of industrial organization, marketing, public finance, and international trade.