When the government levies a specific tax, it imposes a certain amount of tax on each unit of a good or service that is sold. By contrast, an ad valorem tax is a tax in which the government takes a certain percentage of the sale price of each unit that is sold. For example, imagine that a monopolist sells cable TV subscriptions. If the government levies a specific tax, it might require the monopolist to...
When the government levies a specific tax, it imposes a certain amount of tax on each unit of a good or service that is sold. By contrast, an ad valorem tax is a tax in which the government takes a certain percentage of the sale price of each unit that is sold. For example, imagine that a monopolist sells cable TV subscriptions. If the government levies a specific tax, it might require the monopolist to pay $2 for every subscription sold. By contrast, if the government imposes an ad valorem tax it might take 5% of the cost of each subscription. This means that, if the monopolist sold a subscription for $50 per month, it would have to pay $2.50 of that in tax.
A monopolist will like the specific tax better. The monopolist only has to pay that flat rate for each unit sold. This means that, when the monopolist raises the price of the good or service, they do not have to share that new revenue with the government. In our example, if the monopolist raises the price of the subscription from $50 to $55, they still pay the government only $2 and they are able to keep the further $5 per subscription. If there is an ad valorem tax and the monopolist raises prices by this same amount, the government will take $.25 of the $5 increase. Therefore, a monopolist will prefer a specific tax where they can keep all of the marginal revenue gained when they raise prices.
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