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Optimal Taxation and Market Power

Author

Listed:
  • Jan Eeckhout
  • Chunyang Fu
  • Wenjian Li
  • Xi Weng

Abstract

Should optimal income taxation change when firms have market power? We analyze how the planner can optimally tax labor income of workers and profits of entrepreneurs. We derive optimal tax rates that depend on markups and identify four distinct components: the Mirrleesian incentive effect, the Pigouvian tax correction of the negative externality of market power, redistribution through altered factor prices, and reallocation of output toward the most productive firms. We quantify the optimal tax for the US economy and provide concrete proposals how to use income taxation to redistribute income while incentivizing production in the presence of market power.

Suggested Citation

  • Jan Eeckhout & Chunyang Fu & Wenjian Li & Xi Weng, 2026. "Optimal Taxation and Market Power," American Economic Review, American Economic Association, vol. 116(1), pages 119-163, January.
    • Handle: RePEc:aea:aecrev:v:116:y:2026:i:1:p:119-63
    DOI: 10.1257/aer.20211445
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    Cited by:

    1. is not listed on IDEAS
    2. Alexander Tarasov & Robertas Zubrickas, 2023. "Optimal income taxation under monopolistic competition," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 76(2), pages 495-523, August.
    3. Louis Kaplow, 2024. "Optimal Income Taxation," Journal of Economic Literature, American Economic Association, vol. 62(2), pages 637-738, June.
    4. González, Ignacio & Montecino, Juan A. & Stiglitz, Joseph E., 2025. "Equity prices, market power, and optimal corporate tax policy," European Economic Review, Elsevier, vol. 176(C).
    5. Orhan Erem Atesagaoglu & Hakki Yazici, 2021. "Optimal Taxation of Capital in the Presence of Declining Labor Share," CESifo Working Paper Series 9101, CESifo.
    6. Eren Gürer, 2024. "Monopolistic competition, rising markups, and optimal taxation of participation," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 26(1), February.
    7. Hummel, Albert Jan, 2023. "Tax curvature," Journal of Public Economics, Elsevier, vol. 224(C).
    8. Albert Jan Hummel, 2021. "Tax Curvature," CESifo Working Paper Series 9220, CESifo.
    9. Dami'an Vergara, 2022. "Minimum Wages and Optimal Redistribution," Papers 2202.00839, arXiv.org, revised Dec 2022.

    More about this item

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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