Pass-through, welfare, and incidence under imperfect competition

Abstract

This paper provides a comprehensive framework to study welfare effects of multiple policy interventions and other external changes under imperfect competition with emphasis on specific and ad valorem taxation as a leading case. Specifically, in relation to tax pass-through, we provide “sufficient statistics” formulas for two welfare measures under a fairly general class of demand, production cost, and market competition. The measures are (i) marginal value of public funds (i.e., the marginal change in consumer and producer surplus relative to an increase in the net cost to the government), and (ii) incidence (i.e., the ratio of a marginal change in consumer surplus to a marginal change in producer surplus). We begin with the case of symmetric firms facing both unit and ad valorem taxes to derive a simple and empirically relevant set of formulas. Then, we provide a substantial generalization of these results to encompass firm heterogeneity by using the idea of tax revenue that is specified as a general function parameterized by a vector of policy instruments including government and non-government interventions and costs other than taxation.