Ad Valorem Tax Regimes and Differentiated Products: Evidence from the Irish Automobile Market

We examine carbon taxes in the Irish automobiles market where an ad valorem Vehicle Registration Tax (VRT) increased with engine size. We develop a theoretical model to explore how heterogeneous ad valorem taxation can drive... [ view full abstract ]

We examine carbon taxes in the Irish automobiles market where an ad valorem Vehicle Registration Tax (VRT) increased with engine size. We develop a theoretical model to explore how heterogeneous ad valorem taxation can drive imperfect short run price competition, sales and social welfare. We employ a structural model of product demand and supply using a panel data for the Irish automobiles during the period 2004-2008 to estimate utility and cost primitives for products in the presence of heterogeneous ad valorem taxation by engine size. In equilibrium we simulate the actual own-tax and cross-tax semi-elasticises on
pricing. To numerically assess the distortions caused by di erentiated taxation we simulate a counterfactual by imposing homogeneous taxation on products. Consistent with our theory, our empirical analysis suggests that strategic price responses to di erentiated tax regimes, taxing bigger engine size more, mitigates a reallocation of sales away from large down to small engine segments. Large car segments decrease their prices to protect market share. Small car segments take advantage of the tax break to increase their prices. This leads to a reallocation of consumer surplus and producer rents down to the small car segment with little change in the market share of small cars. Increased taxation and pro ts may lead to investment in carbon abatement in the medium to long term but in the short run carbon dirty (clean) engines just got cheaper (more expensive).