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Optimal taxation with imperfect competition and aggregate returns to specialization

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Author Info
Javier Coto-Martínez
Carlos Garriga
Fernando Sánchez-Losada

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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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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2007-036.

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Date of creation: 2007
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Publication status: Published in Journal of The European Economic Association (JEEA), December 2007, 5(6), pp. 1269-99
Handle: RePEc:fip:fedlwp:2007-036

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Keywords: Taxation ; Fiscal policy;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
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  2. Kenneth L. Judd, 2002. "Capital-Income Taxation with Imperfect Competition," American Economic Review, American Economic Association, vol. 92(2), pages 417-421, May. [Downloadable!]
  3. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September. [Downloadable!] (restricted)
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  5. Guo, Jang-Ting & Lansing, Kevin J., 1999. "Optimal taxation of capital income with imperfectly competitive product markets," Journal of Economic Dynamics and Control, Elsevier, vol. 23(7), pages 967-995, June. [Downloadable!] (restricted)
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  6. Ellen R. McGrattan & Edward C. Prescott, 2000. "Is the stock market overvalued?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 20-40. [Downloadable!]
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  7. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2003. "Optimal Indirect and Capital Taxation," Review of Economic Studies, Blackwell Publishing, vol. 70(3), pages 569-587, 07. [Downloadable!] (restricted)
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  8. Benassy, Jean-Pascal, 1996. "Taste for variety and optimum production patterns in monopolistic competition," Economics Letters, Elsevier, vol. 52(1), pages 41-47, July. [Downloadable!] (restricted)
  9. V. V. Chari & Patrick J. Kehoe, 1999. "Optimal Fiscal and Monetary Policy," NBER Working Papers 6891, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Ethier, Wilfred J, 1982. "National and International Returns to Scale in the Modern Theory of International Trade," American Economic Review, American Economic Association, vol. 72(3), pages 389-405, June. [Downloadable!] (restricted)
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  12. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May. [Downloadable!] (restricted)
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  14. Schmitt-Grohe, Stephanie, 1997. "Comparing Four Models of Aggregate Fluctuations due to Self-Fulfilling Expectations," Journal of Economic Theory, Elsevier, vol. 72(1), pages 96-147, January. [Downloadable!] (restricted)
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  15. Charles I. Jones & John C. Williams, . "Too Much of a Good Thing? The Economics of Investment in R&D," Working Papers 95006, Stanford University, Department of Economics.
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  16. Wu, Yangru & Zhang, Junxi, 2000. "Endogenous markups and the effects of income taxation:: Theory and evidence from OECD countries," Journal of Public Economics, Elsevier, vol. 77(3), pages 383-406, September. [Downloadable!] (restricted)
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  18. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under imperfect competition," Journal of Macroeconomics, Elsevier, vol. 26(2), pages 183-209, June. [Downloadable!] (restricted)
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  19. Kim, Jinill, 2004. "What determines aggregate returns to scale?," Journal of Economic Dynamics and Control, Elsevier, vol. 28(8), pages 1577-1594, June. [Downloadable!] (restricted)
  20. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October. [Downloadable!] (restricted)
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  21. Kiminori Matsuyama, 1995. "Complementarities and Cumulative Processes in Models of Monopolistic Competition," Journal of Economic Literature, American Economic Association, vol. 33(2), pages 701-729, June. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Daniel Cardona & Fernando Sanchez Losada, 2007. "Cost-Based Models of Economic Growth," Working Papers in Economics 179, Universitat de Barcelona. Espai de Recerca en Economia. [Downloadable!]
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