The Effect of Taxation on Strategic Entry

Abstract

This note studies the effect of production taxation on entry in a standard Spence-Dixit model of entry game. Taxation reduces both the sunk cost thresholds that block and deter the potential competitor's entry. However, the interaction between taxation and market structure can have important policy implications: in fact, for appropriate ranges of tax rates, a contested monopoly can generate higher tax revenues and social welfare than a Stackelberg duopoly.