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Optimal taxation with imperfect competition and aggregate returns to specialization

  • Javier Coto-Martínez
  • Carlos Garriga
  • Fernando Sánchez-Losada

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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File URL: http://research.stlouisfed.org/wp/2007/2007-036.pdf
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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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  1. Benassy, Jean-Pascal, 1998. "Is there always too little research in endogenous growth with expanding product variety?," European Economic Review, Elsevier, vol. 42(1), pages 61-69, January.
  2. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
  3. Charles I. Jones & John C. Williams, 1999. "Too Much of a Good Thing? The Economics of Investment in R&D," NBER Working Papers 7283, National Bureau of Economic Research, Inc.
  4. 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.
  5. Benassy, Jean-Pascal, 1996. "Taste for variety and optimum production patterns in monopolistic competition," Economics Letters, Elsevier, vol. 52(1), pages 41-47, July.
  6. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  7. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2001. "Optimal indirect and capital taxation," Staff Report 293, Federal Reserve Bank of Minneapolis.
  8. V. V. Chari & Patrick J. Kehoe, 1999. "Optimal Fiscal and Monetary Policy," NBER Working Papers 6891, National Bureau of Economic Research, Inc.
  9. Alan J. Auerbach & James R. Hines Jr., 2001. "Taxation and Economic Efficiency," NBER Working Papers 8181, National Bureau of Economic Research, Inc.
  10. 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.
  11. 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.
  12. Kiminiori Matsuyama, 1994. "Complementaries and Cumulative Processes In Models of Monopolistic Competition," Discussion Papers 1106, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  13. 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.
  14. Mankiw, N. Gregory & Weinzierl, Matthew, 2006. "Dynamic scoring: A back-of-the-envelope guide," Journal of Public Economics, Elsevier, vol. 90(8-9), pages 1415-1433, September.
  15. Kenneth L. Judd, 1997. "The Optimal Tax Rate for Capital Income is Negative," NBER Working Papers 6004, National Bureau of Economic Research, Inc.
  16. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  17. Ellen R. McGrattan & Edward C. Prescott, 2000. "Is the stock market overvalued?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 20-40.
  18. Kenneth L. Judd, 2002. "Capital-Income Taxation with Imperfect Competition," American Economic Review, American Economic Association, vol. 92(2), pages 417-421, May.
  19. Kim, Jinill, 2004. "What determines aggregate returns to scale?," Journal of Economic Dynamics and Control, Elsevier, vol. 28(8), pages 1577-1594, June.
  20. 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.
  21. 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.
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