Beruflich Dokumente
Kultur Dokumente
Jim Y. Jin
Laurence Lasselle1
October 2005
Abstract: In a competitive market with a linear demand and cost structure, Ramsey
(1927) shows that unit taxes which reduce all product quantities by the same proportion
cause the least social loss for any given tax revenue. This paper explores this result in
imperfectly competitive markets: monopoly, Cournot oligopoly and Bertrand oligopoly.
Our main findings are: (1) The impact of Ramsey’s proportional tax is robust in all
markets, e.g. the tax revenue maximization tax rate is the same whatever the market
structure. (2) If Ramsey’s proportional tax only remains efficient in monopoly, it
maximizes the potential tax revenue in all frameworks. (3) We provide the efficient
taxes in all markets and demonstrate that they can always be approached by the same
simple adjustment process.
1
Corresponding author: University of St. Andrews, School of Economics & Finance, St.
Andrews, Fife, KY16 9AL, U.K. E-mail: LL5@st-andrews.ac.uk, Tel: 00 44 1334 462 451,
Fax: 00 44 1334 462 444.
We thank Gerald Pech, Rahab Amir, and participants of seminars at Heriot-Watt University,
the University of St. Andrews, the PET2005 Conference and the CEPET2005 Workshop for
their constructive comments. The responsibility for any remaining errors is solely ours.
This work was partly completed while Laurence Lasselle was visiting the Economics
Department of the European University Institute, Florence, Italy. She is thankful to the Royal
Society of Edinburgh for the funding of her visit.
1. Introduction
In a competitive market with a linear demand and cost structure, Ramsey (1927)
explained how to minimize social loss when the government has to collect a certain
products upon which unit taxes were levied. He obtained an elegant result: the efficient
tax reduces all outputs by a same proportion. For the sake of brevity, the tax issued
from Ramsey’s minimization problem is labeled in this paper “Ramsey tax”. One of
Ramsey’s tax features is its proportionality (…). Ramsey’s outcome has become one
However, the reality of imperfect competition in most markets today raises a question
about its robustness. This paper is an attempt to answer this question by exploring his
Bertrand oligopoly. Our extension is essential not only because perfect competition is
goods are more likely to be associated with imperfectly competitive markets, but also
because the welfare analysis is more relevant and important under imperfect
competition. As we shall see, Ramsey’s result is quite robust in all three markets. For
instance, the tax revenue maximization tax rate is the same whatever the market
structure. However, if the Ramsey tax only remains efficient in monopoly, it maximizes
One could wonder why this extension has not been carried out earlier. We believe that
1
there are at least three reasons. First, let us remind that Ramsey’s contribution seems to
have been overlooked for more than forty years. Sandmo (1976, p. 38) recalls that “in
spite of its exposure to the profession the analysis seems to have fallen into oblivion for
many years. It was hardly mentioned in textbooks on public finance, nor did it have any
impact on the analysis of the welfare economics of the second best.” Pigou, who had
suggested the research to Ramsey [see Ramsey (1927, p. 47)] did mention Ramsey’s
work in the first two editions of his famous book “A study in Public Finance” (1928 p.
126, 1929 p. 130 and in a footnote p. 128) and discussed it more extensively in the third
edition (1947, pp. 100-5). He stressed that “the optimum system of proportionate taxes
yielding a given revenue will cut down the production of all commodities and services
in a 1951 memo to the U.S. treasury. Second, Ramsey’s framework seems to be too
restrictive on the demand side [see Myles (1995)], or even too simple as noted by
Atkinson-Stiglitz (1980). Samuelson (1982, p. 177) called it even “too ambiguous, too
ill defined”. But it found an advocate in Mirrlees (1976), where the latter strongly
argued that what was really relevant was to obtain the real effect of the tax system upon
the equilibrium quantity of each good. Nevertheless, “it was around 1970 that there
began a general revival” of the optimal taxation topic [Sandmo (1976, p. 39)] “with
publication of articles by Baumol and Bradford (1970), Lerner (1970), Dixit (1970) and
represents a major generalization and extension of Ramsey formulation”. The field was
then well established and gained its recognition in top journals and textbooks. Third,
2
economists often remind Ramsey’s generalized result in terms of demand elasticity for
Over the last three decades, the literature on the topic has not only given a deeper
theoretical analysis with more general frameworks (assumptions on the demand side
have been notably relaxed), but it has also led to, through experiments, the effects of the
implementation of the different taxes. It has also moved from the strict efficiency
criterion to that of optimality which is concerned with both efficiency and fairness.
More recently, research has more focused on the impact of ad valorem and excise taxes
on market outcomes (that is to say prices and output) on the one hand and on welfare on
Skeath and Trandel (1994) showed that ad valorem tax Pareto dominates a unit tax in all
Cournot oligopolies. Anderson et al. (2001) analyzed the incidence of these two taxes in
taxation could damage the consumer welfare (the consumer burden could be more than
100%) but might, under certain conditions, enlarge firms’ short profits. Denicolo and
Matteuzzi (2000) considered ad valorem and other specific taxes in Cournot oligopoly.
They proved that if the tax rates are sufficiently high, ad valorem tax welfare dominates
specific tax in the sense that the former leads to greater tax revenue, consumer surplus,
and industry profits. Fershtman et al. (1999) estimated the effects of changing tax
regimes in Cournot oligopoly with differentiated products, using empirical data from the
goods that are sold as well as relative prices in a way that depends on the elasticity of
3
demand of all products and the degree of competition in the market. Finally,
Gabszewicz and Grazzini (1999) and Coady and Drèze (2002) introduced a policy
dimension. The former investigated the effectiveness of tax and transfer policies in
correcting market failures in imperfect competition settings. The latter explained the role
rule for optimum taxation. However, it seems that the study of the effects of the Ramsey
tax on market outcomes and welfare have not been examined in imperfectly competitive
markets.
One obvious reason is the intractability of oligopoly markets, especially when their
demand and/or costs are non-linear. In the present paper, we adapt Ramsey’s original
which generates linear demands. This linearity restriction is necessary for our analysis of
the Ramsey tax’s incidence in imperfect competition which aims at answering the
following questions. When a Ramsey tax is imposed, what common results in all
markets in terms of market outcomes and welfare can be obtained? Is a Ramsey tax still
efficient for any given tax revenue in imperfect competition? If not, what does it
maximize? In this latter case, what is then the efficient tax in imperfect competition?
How can it be easily reached? Our main findings are: (1) The impact of the Ramsey tax
is quite robust in all markets. (2) The Ramsey tax is efficient only in competitive market
and in monopoly. It always maximizes the potential tax revenue. (3) We can evaluate
the efficient taxes in all markets and prove they can always be approached by the same
4
simple adjustment process.
The paper is organized as follows. The next section presents our models. Section 3
investigates the common implications of the Ramsey tax in terms of market outcomes
and welfare of the Ramsey tax in all markets. In Section 4, we show twofold. The
Ramsey tax is always efficient in competitive market and in monopoly. It maximizes the
potential tax revenue in all markets. In Section 5, we provide the efficient taxes in four
2. The Models
constant marginal cost ci and we denote the n × 1 cost vector by c . The representative
and the price vector is p. The consumer has a fixed income W and chooses a
concave, the efficient demand vector x can be solved from the first-order condition:
5
a−Bx−p = 0 .
In quantity competition firms face an inverse demand function for a n-firm Cournot
n
can write this inverse demand function for firm i as: pi ( x ) = ai − ∑ bij x j . Every firm
j =1
⎛ n
⎞
i chooses its output xi to maximize its profit xi ⎜ ai − ci − ∑ bij x j ⎟ . Its first-order
⎝ j =1 ⎠
n
write the demand function for firm i as: xi ( p ) = α i − ∑ βij p j . Every firm chooses its
j =1
⎛ n ⎞
price pi to maximize its profit ( i i ) ⎜ i ∑ β ij p j ⎟ . Its first-order condition is
p − c α −
⎝ j =1 ⎠
In all four markets, each good i is taxed at a unit rate ti and we denote the n × 1 tax
6
vector by t, the after-tax output being denoted by xi ,t . We define a Ramsey tax as
0 ≤ r ≤ 1 . Ramsey (1927) showed that unit taxes reducing output proportionally are
efficient in competitive markets. This paper will assess whether this result still hold in
three imperfectly competitive markets. For that purpose, we will first evaluate the
impact of the Ramsey tax on the market outcomes and welfare. Then we will see
whether this tax is still efficient in imperfect competition. If not, we will establish what
In this section, we examine the Ramsey tax in our three imperfectly competitive markets.
We analyze its consequences on the market outcomes and the welfare in four markets: a
competitive market, monopoly, Cournot and Bertrand oligopolies. First of all, we solve
Proposition 1: Given a unit tax t, the equilibrium output can be written as:
x*t = H ( a − c − t ) (1)
(B + Λ )
−1 −1
in a competitive market, monopoly, Cournot and Bertrand oligopolies,
respectively.
Proof: Appendix A.
7
Given (1), it is easy to compute the Ramsey tax and evaluate its impact on prices and
outputs.
xi*,t = (1 − r ) xi* and pi*,t = r ai + (1 − r ) pi* . The tax revenue maximization tax rate is a
Proposition 2 states that the Ramsey tax is valid in all commonly used market models.
difference between the marginal utility parameter ai and the marginal cost ci . The
can evaluate not only the impact of the Ramsey tax on market outcomes, but also as
we shall see below, its consequences on welfare. Proposition 2 also points out that the
Ramsey tax always leads in all models to the same proportional output reduction of
(1 − r ) and price rise of r ( ai − pi* ) . Finally, Proposition 2 implies a tax revenue equal
Ramsey’s case (competitive market) the tax revenue maximization is equivalent to the
social welfare maximization. In our case, the tax revenue maximization is not only that
subject to a Ramsey tax, but also that subject to any unit tax.
8
Let us now study the welfare effects of the Ramsey tax. From our framework presented
Proposition 3: Given a Ramsey tax t = r ( a − c ) with 0 < r ≤ 0.5 , the profit, consumer
SWt* = (1 − r 2 ) SW * − r (1 − r ) π * .
Simple and uniform relationships between pre-tax and after-tax expressions can be
extended to the welfare measures. While profits and consumer surplus always fall to
(1 − r )
2
of their pre-tax levels in all four markets, the relative social loss depends on the
nature of competition. Recall that in a competitive market, π * = 0 , the Ramsey tax leads
to the loss of (1 − r 2 ) of the pre-tax social welfare. As market power increases, π * is not
nil anymore and becomes higher, losses go up. Indeed, recall that in monopoly
9
Let us now turn to the amount of tax revenue and its incidence on consumers and
producers. Given our notations, the consumer burden and the producer burden can be
2CS * π * . When the tax revenue is maximized, the consumer burden and producer
This proposition tells us that the maximum tax revenue is equal to 2 CSt* + π t* . Although
the expression of the Ramsey tax is identical in all four markets, the corresponding
revenues are different. Indeed, given t = r ( a − c ) , the corresponding tax revenue could
be ranked according to the nature of the competition, but only if outputs can.
Unfortunately, this is not the case. Although, the equilibrium quantities are the highest
For instance, Bertrand and Cournot outputs cannot be compared with monopoly ones in
a model with a mixture of substitute and complement goods [see Amir and Jin (2001)].
Nevertheless, revenue comparison for a given Ramsey tax leads to an interesting result.
follow: 2 RtM = RtPC > RtB > RtC . In addition, if goods are substitutes
10
( ∂xi ∂ p j ≥ 0 ), RtB > RtM , for complements ( ∂ pi ∂x j ≥ 0 ), RtM > RtC .
Proposition 5 implies that for the same Ramsey tax, the more competitive a market is,
Up to now, we have demonstrated that the Ramsey tax yields a number of simple
relations for all four markets. Our next work is to check whether this tax is still efficient
for any given tax revenue in imperfect competition. If not, we will need to ask what this
tax maximizes then. To facilitate the understanding of our forthcoming results, let us
consider two unit taxes imposed sequentially. At a given time, the government decides
to levy a unit tax t and receives a tax revenue Rt = t′ H ( a − c − t ) . After that, if the
government wants to implement an additional unit tax τ , it will receive a new revenue
defined as “the potential tax revenue” left over by the current tax rate t. It is easy to
Proposition 6: The Ramsey tax t = r ( a − c ) with 0 < r ≤ 0.5 , only maximizes the social
welfare in a competitive market and in monopoly. Given any level of current tax rate ,
the Ramsey tax always maximizes the potential tax revenue which is
R ( t ) = 0.25 (1 r − 1) Rt .
11
Proof: see Appendix F.
Proposition 6 implies the possibility of non efficiency of the Ramsey tax in imperfect
competition. In the case of a competitive market, as profits are always zero, the potential
revenue is equal to 2 CSt* , which is twice of the social welfare, therefore the Ramsey tax
the potential tax revenue is 4 3 of the social welfare. Maximizing the potential tax
revenue will again automatically make the tax efficient as in the competitive case.
However, as Proposition 6 states, the Ramsey tax is not efficient in Cournot and
whatever the market structure considered: its potential tax revenue, for a current level of
taxation.
natural question arises: what is the efficient tax in all markets? If, as argued by
Ramsey (1927), the government wants to minimize the damage to social welfare for
any given tax revenue, its tax rate should maximize a linear function of its tax
The expression of the tax rate derived from this maximization problem is not as simple
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as that of the Ramsey tax, especially in Cournot and Bertrand oligopolies. Let us
emphasize that in this section our goal is to identify a uniform formula for the efficient
tax applicable in all markets, and the corresponding pre-and after-tax relations for the
market outcomes.
S = (1 + γ )( 2I + γ B H )
−1
. The outputs and prices are x*t = S′ x* and
p*t = ( I − S )′ a + S′ p* .
Proof: Appendix G.
The efficient tax expressed in Proposition 7 cannot be called “Ramsey tax” as it does not
always reduce all output proportionally. Nevertheless, it remains the “efficient Ramsey
1+ γ
tax” in competitive and monopoly markets. In the former case, H = B −1 , S = I , so
2+γ
1 1+ γ 2−γ
t* = ( a − c ) . In the latter, H = 0.5 B −1 , S = I , so t * = ( a − c ) . In
2+γ 2 + 0.5γ 4+γ
−1 −1
more complicated and equal to (1 + γ ) ⎡⎣ 2I + γ B ( B + D ) ⎤
⎦
and
−1
(1 + γ ) ⎡⎣⎢ 2I + γ B ( B + Λ −1 ) ⎤⎦⎥
−1
respectively.
Although we still have uniform formulae for the tax and the market outcomes in all four
13
markets, the precise relationship of the tax rate and that of between the market outcomes
Given the complicated formula for the efficient tax, one would ask how to find its exact
value, especially in asymmetric Cournot and Bertrand markets, where the matrix B may
be too complex. This problem can be solved by an adjustment process through market
responses. We are able to show that there exists a uniform updating rule which always
converges to the efficient tax rate t* stated in Proposition 7 in all four markets.
If the government starts with a fixed γ (the marginal revenue increase for a unit of
social loss), it will eventually end up with a certain amount of tax revenue causing the
5. Concluding Comments
This paper has assessed the scope of validity of the well-known Ramsey’s result in
terms of efficiency in simple frameworks with imperfect competition and shows that it
First, we have demonstrated that the Ramsey tax implies simple and uniform output and
price relationships between their pre- and after-tax levels. This part of work also
14
established relations regarding profit, consumer surplus, social welfare, agents’ burdens
and tax revenue. Second, we have shown that the efficiency property of the Ramsey’s
proportional tax has been lost in imperfect competition except for the monopoly case.
The Ramsey tax maximizes an alternative objective function: the potential tax
revenue in all four markets. Third, we have given the expression of the efficient tax
for each of the four markets. Although this expression is not identical in all markets,
there exists a unique formula in all markets. Finally, we provide a simple adjustment
process which always converges towards this tax in the four markets.
The linear demand and cost structure are obviously a limitation of our model.
15
Appendices
p = a − B x , we have a − c = ( B + D ) x , so x* = ( B + D ) (a − c)
−1
. In Bertrand
and ( B + Λ −1 ) in a
−1
and positive matrix, which is equal to B −1 , 0.5 B −1 , ( B + D )
−1
Given the unit tax t, firms’ marginal costs become c + t. So we can write
x*t = H ( a − c − t ) .
Appendix B: x*t = H ( a − c − t ) = (1 − r ) H ( a − c ) = (1 − r ) x* .
16
∂Rt
Rt = t′ x*t = t′ H ( a − c − t ) . From = H ( a − c − 2 t ) = 0 , we find t* = 0.5 ( a − c ) .
∂t
∂ 2 Rt
Note that = −2H is negative definite, as H is always positive definite in the four
∂t 2
= (1 − r ) ( CS * + π * ) + r (1 − r )( a − c )′ x* .
2
SWt* = (1 − r ) ( CS * + π * ) + r (1 − r ) ( 2CS * + π * ) = (1 − r 2 ) SW * − r (1 − r ) π * .
2
Appendix D:
′
PB = ( p* − p*t + t )′ x*t = ⎡⎣ r ( p* − a ) + r ( a − c ) ⎤⎦ x*t = r ( p* − c )′ x*t
= r (1 − r ) ( p* − c )′ x* = r (1 − r ) π * . Therefore CB PB = 2CS * π * .
17
The producer burden is PB = ( p* − p*t + t )′ x*t . As p*t − p* = t′ B H ,
PB = t′ ( I − B H )′ x*t = t′ ( I − H B ) H ( a − c − t ) = t′ ( H − H B H )( a − c − t ) . Simple
is positive definite which is true for all markets. So the producer burden is maximized.
With r = 0.5 , its value is 0.25 π * = π t* .
Rt = t′ x*t = t′ B −1 ( a − p*t ) = r ( a − c )′ B −1 (1 − r ) ( a − p* ) = r (1 − r )( a − c )′ B −1 ( a − p* )
⎢⎣ ⎦⎥
( a − c )′ ⎡⎢⎣( B + Λ −1 ) − ( B + D ) ⎤⎥ ( a − c ) = ( a − c )′ ( B + Λ −1 ) ⎡I − ( B + Λ −1 ) ( B + D ) ⎤ ( a − c ) =
−1 −1 −1 −1
⎦ ⎣ ⎦
( a − c )′ ( B + Λ −1 )
−1
⎡⎣B + D − B + Λ −1 ⎤⎦ ( B + D ) ( a − c ) = x′B ⎡⎣ D − Λ −1 ⎤⎦ xC
−1
D − Λ −1 is positive matrix if bii > 1 β ii for every i. This is true as B is positive definite
18
x B − x M = ⎡⎢( B + Λ −1 ) − 0.5 B −1 ⎤⎥ ( a − c ) = ( B + Λ −1 ) ⎡⎣I − 0.5 ( B + Λ −1 ) B −1 ⎤⎦ ( a − c ) . A few
−1 −1
⎣ ⎦
Recall first that bii − 1 β ii > 0 . If all goods are substitute, ∂xi ∂ p j ≥ 0 for i ≠ j , so
β ij ≤ 0 which implies bij ≥ 0 . Recall that bii − 1 β ii > 0 , therefore x B > x M which
⎛ a − c ⎞′ ⎡ −1 ⎛ a − c ⎞
⎟ ⎣( B + D ) − 0.5B ⎦⎤ ⎜
−1
as RtC − RtM = ⎜ ⎟
⎝ 2 ⎠ ⎝ 2 ⎠
⎛ a − c ⎞′
⎟ ( B + D ) ⎡⎣ 2I − ( B + D ) B ⎤⎦ ( a − c )
−1 −1
=⎜ . A few computations yield
⎝ 8 ⎠
⎛ a − c ⎞′ B −1
xC = ( B + D ) (a − c)
−1
⎟ ( B + D ) [ B − D] (a − c)
−1
RtC − RtM = ⎜ . Recall and
⎝ 4 ⎠ 2
0.25 xC′ [ B − D] x M . If all goods are complements, bij ≤ 0 , and therefore Rt < Rt .
C M
19
xt = H ( a − c − t ) , L = ⎡⎣ t + γ ( a − c ) − 0.5γ B H ( a − c − t ) ⎤⎦′ H ( a − c − t ) . Simple
t * = ( 2I + γ BH ) ⎡⎣(1 − γ ) I + BH ⎤⎦′ ( a − c ) = ( I − S )′ ( a − c )
−1
efficient tax where
S = (1 + γ )( 2I + γ B H ) .
−1
x*t = H ( a − c − t * ) = HS′ ( a − c ) = (1 + γ ) ( 2H −1 + γ B )
−1
(a − c)
= (1 + γ )( 2I + γ HB ) H ( a − c ) = S′x* .
−1
p*t = a − Bx*t = a − B S′ x* = a − (1 + γ ) B ( 2I + γ HB ) x* = a − (1 + γ ) ( 2B −1 + γ H ) x*
−1 −1
= a − (1 + γ )( 2I + γ BH ) Bx* = a − S′ ( a − p* ) = ( I − S )′ a + S′p* .
−1
the efficient tax t* as 0.5 ⎡⎣a − c − γ ( p*T − c ) ⎤⎦ . Hence we have t k − t * = 0.5 γ ( p*T − p k ) .
wk +1 − wk = 0.25γ 2 ( t k − t* )′ HBH ( t k − t * ) − ( t k − t* )′ B −1 ( t k − t* ) .
20
= ( t k − t* )′ H ( 0.25γ 2 B − H −1B −1H −1 ) H ( t k − t* ) , the series of wk decreases for t k ≠ t*
are both negative definite if γ < 2 . Hence, wk must have a limit, i.e. lim ( wk +1 − wk ) = 0 .
k →∞
lim {t k } = t* .
k →∞
21
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