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Optimal Tax Policy and Wage Subsidy in an Imperfectly Competitive Economy

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Abstract

In an imperfectly competitive economy with direct and indirect taxes, the first best wage subsidy overcompensates workers and provides the incentive to misreport working hours. We show that in the second best optimum where the government cannot use a wage subsidy, the optimal policy is to tax labour income at a zero rate. This policy is optimal because it minimizes the incentive to misreport working hours.

Suggested Citation

  • Selim, Sheikh, 2010. "Optimal Tax Policy and Wage Subsidy in an Imperfectly Competitive Economy," Cardiff Economics Working Papers E2010/15, Cardiff University, Cardiff Business School, Economics Section.
    • Handle: RePEc:cdf:wpaper:2010/15
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    1. ColemanII, Wilbur John, 2000. "Welfare and optimum dynamic taxation of consumption and income," Journal of Public Economics, Elsevier, vol. 76(1), pages 1-39, April.
    2. 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.
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    Keywords

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    JEL classification:

    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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