A PARETO COMPARISON OF AD-VALOREM AND UNIT TAXES IN NONCOMPETITIVE ENVIRONMENTS

A literature that began with Wicksell (1896) has shown that an ad valorem tax is welfare superior to an equal-yield unit tax in both monopoly and oligopoly markets. This paper proves a stronger result: for any unit tax imposed on a monopoly, there exists an ad valorem tax that Pareto dominates it - that produces larger profit, tax revenue, and consumer surplus. The paper then considers whether this Pareto result generalizes to all Cournot-Nash oligopolies. The paper shows that Pareto dominance holds in such markets whenever the tax level exceeds a critical value that depends on various market parameters.