A welfare anomaly in the rate-of-return regulated monopoly model which creates opportunities for offsetting taxation and regulatory policies

Abstract

The impact of the property tax on a fair rate of return regulated firm is examined. We find that a change in the tax rate has exactly the same effect on factor employment, output and hence the price as an equivalent change in the allowed rate of return. However, an increase in the allowed rate of return will lead to higher profits, whereas the same increase in the property tax rate will decrease profits. We find that an increase in the tax rate or allowed rate of return may result in a net increase in social welfare. This result contradicts the long-established belief that a lower (or no) tax is preferred to a higher tax rate in maximizing welfare. Finally, a linear iso-welfare locus is derived which creates the possibility of the regulatory agency or the tax authority offsetting the negative effects of the other's policy.