Product Quality and Taxation: a Reconciliation

Abstract

Within the last few years, two articles in this journal (one ours) have discussed the relationship between product quality, excise taxes, and tax revenue. The articles are marked by seemingly contradictory results regarding the effect specific taxes and ad valorem taxes have on product quality. This article reconciles the contradiction. The authors show that the difference stems from opposite assumptions about the substitutability between physical units and their quality attributes. For all intermediate substitutabilities, the tax-quality relationship of this article is relevant for specific taxes, while the tax-quality relationship of the other article is relevant for ad valorem taxes.