Research / BFI Working PaperMay 24, 2021

A Welfare Analysis of Tax Structures with Love-of-Variety Preferences

Kory Kroft, Jean-William P. Laliberté, René Leal Vizcaíno, Matthew J. Notowidigdo

This paper reassesses the general trade-off between ad valorem and specific taxation using an economic model that features love-of-variety preferences and encompasses a wide range of market conduct –including both quantity and price competition – while allowing for firm entry and exit. We derive formulas for efficiency and incidence of both types of taxes that depend on the responsiveness of product variety to taxes and the effect of a change in product variety on consumer surplus. We use our formulas to derive a desirability condition for when ad valorem taxes are more efficient than specific taxes and a condition for when ad valorem taxes lead to greater pass-through than specific taxes. We identify and estimate the model parameters using a quasi-experimental “county border pair” research design that uses state-level and county-level variation in sales taxes combined with detailed scanner data covering grocery stores in the U.S. Our empirical results indicate that sales taxes are slightly overshifted onto consumer prices, have a large effect on quantity demanded, and have a more modest effect on the variety of products available to consumers. Using the estimated parameters, we recover consumers’ love-of-variety, infer whether or not product variety is socially optimal (at current tax rates), and implement our desirability condition. We find that specific taxes are more efficient at the margin than ad valorem taxes given the estimated love-of-variety. This suggests that policymakers should consider using specific taxes and tariffs in markets with substantial product differentiation.

Additional Materials

More Research From These Scholars

BFI Working Paper Aug 31, 2020

Who Profits From Amateurism? Rent-Sharing in Modern College Sports

Craig Garthwaite, Jordan Keener, Matthew J. Notowidigdo, Nicole F. Ozminkowski
Topics:  Higher Education & Workforce Training
BFI Working Paper Sep 30, 2020

Temporary Unemployment and Labor Market Dynamics During the COVID-19 Recession

Jessica Gallant, Kory Kroft, Fabian Lange, Matthew J. Notowidigdo
Topics:  Employment & Wages
Journal Article May 2, 2019

Take-Up and Targeting: Experimental Evidence from SNAP

Amy Finkelstein, Matthew J. Notowidigdo
Topics:  Uncategorized