Working Paper

Optimal taxation with imperfect competition and aggregate returns to specialization

Abstract: In this paper we explore the proposition that in economies with imperfect competitive markets the optimal capital income tax is negative and the optimal tax on firms profits is confiscatory. We show that if the total factor productivity as well as the measure of firms or varieties are endogenous instead of fixed, then the optimal fiscal policy can lead to different results. The government faces a trade-off between the fixed costs that society pays for the introduction of a new firm and the productivity gains associated to the introduction of a new variety. We find that the optimal fiscal policy depends on the relationship between the index of market power, the returns to specialization, and the government?s ability to control entry.

Keywords: Taxation; Fiscal policy;

Status: Published in Journal of The European Economic Association (JEEA), December 2007, 5(6), pp. 1269-99

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2007

Number: 2007-036