Does tax policy work when consumers have imperfect price information? Theory and evidence

Abstract

We investigate how the pass-through rate of commodity taxes depends on competition in a setting where consumers have imperfect information about prices. We use a theoretical search model that has two key predictions. First, the larger the number of price sensitive consumers, the higher the pass-through rate. Second, there is a hump-shaped relationship between the average pass-through experienced by consumers and the number of sellers. We test our theoretical predictions by studying pass-through in the context of a tax decrease and increase in the German retail fuel market. We estimate pass-through of these tax changes to diesel and gasoline prices using a unique dataset containing the universe of price changes at fuel stations in Germany and France and a synthetic difference-in-differences strategy. Our empirical results are in line with our theoretical predictions. Finally, we show that our theoretical framework can encompass and reconcile a large number of empirical observations in previous studies.

Publication
CESifo Working Paper Nr. 9138
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