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Federal Reserve Bank of St. Louis
Working Papers
Optimal taxation with imperfect competition and aggregate returns to specialization
Javier Coto-Martínez
Carlos Garriga
Fernando Sánchez-Losada
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.


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Javier Coto-Martínez & Carlos Garriga & Fernando Sánchez-Losada, Optimal taxation with imperfect competition and aggregate returns to specialization, Federal Reserve Bank of St. Louis, Working Papers 2007-036, 2007.
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Keywords: Taxation ; Fiscal policy
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