TITLE:
The Welfare Comparison of Ad-Valorem Tax and Specific Tax with Both Quality and Quantity Choice of a Consumer
AUTHORS:
Takuya Obara, Shuichi Tsugawa
KEYWORDS:
Quality Choice of a Consumer, Specific Tax, Ad-Valorem Tax, Substitution Effect, Welfare Comparison
JOURNAL NAME:
Theoretical Economics Letters,
Vol.7 No.6,
October
26,
2017
ABSTRACT: This
paper compares ad-valorem and specific taxation in models where a
representative consumer with an exogenous income has both a quality and a
quantity choice under perfect competition. In the setting, while ad-valorem tax
causes income effect only, specific tax causes both income effect and
substitution effect. Therefore, ad-valorem tax decreases consumer demand for
both quality and quantity; on the other hand, specific tax decreases consumer demand
for quantity. However, the sign of consumer demand for quality is ambiguous and
is determined by the curvature of marginal utility on quantity. Additionally,
using a constant elasticity of substitution (CES) utility function and a linear
price function, we show that ad-valorem tax is superior to specific tax except
for the Leontief preference under which the two forms of commodity taxes
generate the same tax revenue. The substitution effect caused by specific tax
disappears if the elasticity of substitution converges to zero.