Product Quality and the Optimal Structure of Commodity Taxes

• Author: SOFIA DELIPALLA,MICHAEL KEEN
• Date: 01 October 2006
• DOI: http://doi.org/10.1111/j.1467-9779.2006.00277.x
• Published date: 01 October 2006

PRODUCT QUALITY AND THE OPTIMAL STRUCTURE

OF COMMODITY TAXES

SOFIA DELIPALLA

University of Macedonia

MICHAEL KEEN

International Monetary Fund

Abstract

The comparison between ad valorem and specific taxation is among

the oldest issues in formal public finance and is important for policy

in the European Union (EU) and elsewhere. This paper develops

and articulates simple but very general elasticity rules that character-

ize the optimal balance between the two in a model of endogenous

product quality. These rules temper the preference for ad valorem

taxation that emerges from homogeneous product models, pointing

to relatively heavy reliance on whichever form of taxation has the

least effect on product quality.

1. Introduction

Commodity taxes are generally levied in one or, especially for heavily taxed

goods, both of two forms: ad valorem (tax specified as some proportion of

the selling price) or specific (tax specified as some fixed amount per unit

of the good). The comparison between the two outside the perfectly com-

petitive case, in which they are well known to be equivalent, is one of the

oldest topics in the formal theory of public finance—the seminal contribu-

tions being those of Suits and Musgrave (1955), Wicksell (1959), and Cournot

(1960)—and has been returned to by, among others, Kay and Keen (1983,

Sofia Delipalla, Department of Balkan, Slavic and Oriental Studies, University of Mace-

donia (Economic and Social Sciences), 156 Egnatia Street, Thessaloniki 54006, Greece

(sd@uom.gr). Michael Keen, International Monetary Fund, 700 19th Street NW, Washing-

ton, DC 20431 (mkeen@imf.org).

We are very grateful to an anonymous referee for useful suggestions and are especially

indebted to Jim Mirrlees, whose comments considerably improved our proofs. The views

expressed here are not necessarily those of the International Monetary Fund. Opinions

and errors are ours alone.

Received September 1, 2004; Accepted March 16, 2005.

© 2006 Blackwell Publishing, Inc.

Journal of Public Economic Theory, 8 (4), 2006, pp. 547–554.

547