VAT do you eat? Green consumption taxes and firms' market share

Abstract

AbstractThis paper examines the role of a ‘green’ value‐added tax in the competitive environment of firms. Using data on firms in Romania and leveraging the introduction of a tax reduction on organic products in 2019, I show that although the overall market for organic goods grows and potential to generate windfall profit exists, the market share of incumbent firms decreases because of intensified competition post‐reform driven by new entrants competing for profits in the market. The market share decreases by about 2 percentage points after the reform. The effect depends on the relative elasticity of demand vis‐à‐vis supply in the market and the ability of a firm to protect its sales from new market entrants. Firms operating geographically further from the main consumer (i.e., more rural firms) and further upstream from the retail sector are more vulnerable to losing market share because urban demand is less elastic than rural demand and retail demand is less elastic than primary demand. Firms that are in markets where it is easier to switch from non‐organic to organic and that are less capital intensive (i.e., have fewer fixed costs) are more vulnerable to losing market share to new market entrants.