Specific Taxes, Product Quality, and Rate-Revenue Analysis

Abstract

The effect that specific taxes have on product quality has been a question of interest to economists over the last few years. The problem arises because while goods and services are multidimensional in terms of utility generating characteristics, specific taxes are almost always levied on just one of the characteristics. The effect of quality adjustment on tax revenue has not yet been examined in any detail. Quality adjustment is no doubt a change that occurs over a longer-run time frame. Heretofore, the only attempts at adding a temporal dimension to rate-revenue analysis distinguish between the short run and long run in terms of supply and demand elasticities. In the previous analysis the tax rate at which revenue is maximized and the tax rate at which revenue reaches zero are both lower in the long run. What makes the analysis presented here interesting is that when product quality accounts for the intertemporal distinction, the revenue maximizing tax rate and the tax rate that yields zero revenue are both higher in the long run.