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  5. Optimal Taxation and Market Power

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Optimal Taxation and Market Power

  • Jan Eeckhout
  • Chunyang Fu
  • Wenjian Li
  • Xi Weng
American Economic Review (Forthcoming)

Abstract

Should optimal income taxation change when firms have market power? We analyze how the planner can optimally set taxes on the labor income of workers and on the profits of entrepreneurs to induce a constrained-efficient allocation. Our theory derives optimal tax rates that depend on markups and identifies four distinct components of taxes on welfare: 1. the Mirrleesian incentive effect; 2. the Pigouvian tax correction of the negative externality of market power; 3. redistribution through altered factor prices; 4. reallocation of output towards the most productive firms

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