The Optimal Taxation of Air Travel Under Monopolistic Dynamic Pricing

Abstract

This article re-examines the question of how to optimally tax air travel within the model from Gallego and van Ryzin (1994), in which a monopolistic airline chooses its dynamic pricing policy to sell tickets to randomly arriving consumers over a finite time horizon until the plane departs. In general, the profit maximizing policy differs from the welfare maximizing policy. However, for a certain class of demand functions that includes constant elasticity and exponential demand functions, a simple policy instrument, namely a tax on vacant seats is sufficient to perfectly align profit maximization incentives with welfare maximization. Calibrating the model to predict a load factor of 80% (the current global average), the welfare maximizing tax on vacant seats leads to load factors of 97% for the constant elasticity demand function and 98% for the exponential demand function. These results suggest that club mechanisms for financing Global Public Good Institutions via aviation taxes will create stronger participation incentives if they do not constrain countries to use passenger taxes but instead allow them to use emissions taxes and even taxes on vacant seats.