COMMODITY TAXATION IN A DIFFERENTIATED OLIGOPOLY

We introduce commodity taxation into a vertical differentiation model with endogenous product selection. We show that a uniform ad valorem tax lowers both qualities, distorts the allocation of consumers between firms and lowers the consumer prices of both variants. A small uniform tax is always welfare-improving over the no-tax equilibrium. A differentiation of tax rates may or may not be desirable on welfare grounds. If a welfare improvement is possible through a nonuniform tax, it is always the high-quality variant which must be taxed at a higher rate.