Ad valorem taxation on intermediate goods in oligopoly

The paper compares the efficiency of value added taxation (VAT), in which i ntermediate goods are not taxed, with that of cascade taxation, in which th ey are, when levied on imperfectly-competitive vertically-related industrie s. One type of commodity taxation is not always superior to the other in te rms of welfare. Indeed, when intermediate-goods have close substitutes, VAT is the optimal commodity tax system. But when input substitutability is we ak or absent and input producers have market power, they should be taxed. I n fact, in the absence of lump sum taxes and with no input substitutability , it is optimal to tax, not to subsidize, the most monopolistic industry. T rue cascading, in which both upstream and downstream industries are taxed, is thus better than VAT when, besides no input substitutability and both in termediate and final good producers with market power, the needed revenue r equirement is not small. We therefore submit a rationale for the coexistenc e of VAT and cascade taxation.