Optimal Sin Taxation and Market Power
American Economic Journal: Applied Economics (Forthcoming)
We study how market power impacts the efficiency and redistributive
properties of sin taxation, with an empirical application
to sugar-sweetened beverage taxation. We estimate an equilibrium
model of the UK drinks market, which we embed in a tax design
framework to solve for optimal sugar-sweetened beverage tax policy.
Positive price-cost margins for drinks create inefficiencies
that lower the optimal rate compared with a perfectly competitive
setting. Since profits mainly accrue to the rich, this is partially
mitigated under social preferences for equity. Overall, ignoring
market power when setting tax policy leads to welfare gains 40%
below those at the optimum.