We introduce commodity taxation into a vertical differentiation model
with endogenous product selection. We show that a uniform ad valorem t
ax lowers both qualities, distorts the allocation of consumers between
firms and lowers the consumer prices of both variants. A small unifor
m tax is always welfare-improving over the no-tax equilibrium. A diffe
rentiation of tax rates may or may not be desirable on welfare grounds
. If a welfare improvement is possible through a nonuniform tax, it is
always the high-quality variant which must be taxed at a higher rate.