The Efficiency of Indirect Taxes Under Imperfect Competition

The relative efficiency of ad valorem and unit taxes is analyzed for oligopolistic markets. We provide a simple proof that ad valorem taxes welfare-dominate unit taxes in the short run if production costs are identical across firms. The proof covers a wide range of market conduct and differentiated products. Cost asymmetries strengthen the case for ad valorem taxation under Cournot competition, but unit taxation may be preferred under Bertrand competition with product differentiation. Ad valorem taxation is welfare-superior with free entry under Cournot competition, but unit taxation may be more efficient under price competition if consumers value variety