competition prevents producers from realizing and passing on savings from scaling down in response to a tax hike.
The fourth model generalizes the ‘quality ladder’ model in Khandelwal (2010) to allow for substitution or complementarity effects between consumer valuation of affordability and quality. We find that variation in pass-through depends on price-qualitycomplementarity. For products with longer ‘quality ladders’ where differences in quality are the starkest, we show that pass-through is larger when there is a high enough degree of price-qualitycomplementarity
We examine the role of market characteristics and timing in explaining observed heterogeneity in VAT pass-through. We first extend existing theory to characterize the roles of imperfect competition and product differentiation, then investigate these relationships empirically using a panel of 14 Eurozone countries between 1999 and 2013. We find important roles for product market regulation and product quality, and little impact of advance announcement of reforms. Our findings have important implications for policy-makers considering VAT rate adjustments, by illuminating which of the consumers or the producers would experience the brunt of a reform across different settings.