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Optimal sin taxation and market power

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  • Martin O'Connell

    (Institute for Fiscal Studies and University of Wisconsin)

  • Kate Smith

    (Institute for Fiscal Studies and Institute for Fiscal Studies)

Abstract

This paper studies the design of sin taxes when ?rms exercise market power. We outline an optimal tax framework that highlights how market power impacts the e?ciency and redistributive properties of sin taxation, and quantify these e?ects in an application to sugar-sweetened beverage taxation. We estimate a detailed model of demand and supply for the UK drinks market, which we embed in our tax design framework to solve for optimal sugar-sweetened beverage tax policy. Positive price-cost margins on drinks create allocative distortions, which act to lower the optimal rate compared with a perfectly competitive setting. However, since pro?ts accrue to the rich, this is partially mitigated under social preferences for equity. Overall, ignoring market power when setting the optimal sugar-sweetened beverage tax rate leads to welfare gains that are 40% below those at the optimum. We show that moving from a single tax rate on sugar-sweetened beverages to a multi-rate system can result in further substantial welfare gains, with much of these gains realized by instead taxing sugar content directly.

Suggested Citation

  • Martin O'Connell & Kate Smith, 2021. "Optimal sin taxation and market power," IFS Working Papers W21/30, Institute for Fiscal Studies.
    • Handle: RePEc:ifs:ifsewp:21/30
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    Cited by:

    1. Rosella Levaggi & Carmen Marchiori & Paolo M. Panteghini, 2022. "Lifestyle taxes in the presence of profit shifting," Journal of Economics, Springer, vol. 137(1), pages 81-96, September.
    2. Goncalves, Judite & Merenda, Roxanne & dos Santos, João Pereira, 2022. "Not so sweet: The impact of the Portuguese soda tax on producers," Ruhr Economic Papers 938, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    3. Judite Gonçalves & Roxanne Merenda & João Pereira dos Santos, 2024. "Not so sweet: impacts of a soda tax on producers," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 31(5), pages 1388-1412, October.

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    More about this item

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
    • L66 - Industrial Organization - - Industry Studies: Manufacturing - - - Food; Beverages; Cosmetics; Tobacco

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