IDEAS home Printed from
   My bibliography  Save this paper

Monopoly Power and Optimal Taxation of Labor Income


  • Sheikh Tareq Selim

    (Cardiff University)


This paper studies the Ramsey problem of optimal labor income taxation in a simple model economy which deviates from a first best representative agent economy in three important aspects, namely, flat rate second best tax, monopoly power in intermediate product market, and monopolistic wage setting. There are three key findings: (1) In order to correct for monopoly distortion the Ramsey tax prescription is to set the labor income tax rate lower than its competitive market analogue; (2) Government’s optimal tax policy is independent of its fiscal treatment of distributed pure profits; and (3) For higher levels of monopoly distortions Ramsey policy is more desirable than the first best policy. The key analytical results are verified by a calibration which fits the model to the stylized facts of the US economy.

Suggested Citation

  • Sheikh Tareq Selim, 2005. "Monopoly Power and Optimal Taxation of Labor Income," Macroeconomics 0511002, EconWPA.
  • Handle: RePEc:wpa:wuwpma:0511002 Note: Type of Document - pdf; pages: 33. Cardiff Economics Working Paper Series

    Download full text from publisher

    File URL:
    Download Restriction: no

    References listed on IDEAS

    1. Taylor, John B., 2001. "An Interview With Milton Friedman," Macroeconomic Dynamics, Cambridge University Press, vol. 5(01), pages 101-131, February.
    2. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
    3. Taiji Harashima, 2004. "The Ultimate Source of Inflation: A Microfoundation of the Fiscal Theory of the Price Level," Macroeconomics 0409018, EconWPA, revised 30 Mar 2005.
    4. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, Oxford University Press, vol. 115(1), pages 147-180.
    5. Mankiw, N Gregory, 2001. "The Inexorable and Mysterious Tradeoff between Inflation and Unemployment," Economic Journal, Royal Economic Society, vol. 111(471), pages 45-61, May.
    6. Orphanides, Athanasios & Williams, John C., 2005. "The decline of activist stabilization policy: Natural rate misperceptions, learning, and expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1927-1950, November.
    7. Chari, V. V. & Christiano, Lawrence J. & Eichenbaum, Martin, 1998. "Expectation Traps and Discretion," Journal of Economic Theory, Elsevier, vol. 81(2), pages 462-492, August.
    8. Orphanides, Athanasios, 2003. "The quest for prosperity without inflation," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 633-663, April.
    9. Lawrence J. Christiano & Christopher J. Gust, 2000. "The expectations trap hypothesis," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q II, pages 21-39.
    10. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
    11. Richard Dennis, 2006. "The policy preferences of the US Federal Reserve," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(1), pages 55-77.
    12. repec:cup:macdyn:v:5:y:2001:i:1:p:101-31 is not listed on IDEAS
    13. Timothy Cogley & Thomas J. Sargent, 2002. "Evolving Post-World War II U.S. Inflation Dynamics," NBER Chapters,in: NBER Macroeconomics Annual 2001, Volume 16, pages 331-388 National Bureau of Economic Research, Inc.
    14. Diebold, Francis X & Senhadji, Abdelhak S, 1996. "The Uncertain Unit Root in Real GNP: Comment," American Economic Review, American Economic Association, vol. 86(5), pages 1291-1298, December.
    15. Athanasios Orphanides, 2002. "Monetary-Policy Rules and the Great Inflation," American Economic Review, American Economic Association, vol. 92(2), pages 115-120, May.
    16. Gordon de Brouwer, 1998. "Estimating Output Gaps," RBA Research Discussion Papers rdp9809, Reserve Bank of Australia.
    17. Allan H. Meltzer, 2005. "Origins of the Great Inflation," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 145-176.
    18. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-491, June.
    Full references (including those not matched with items on IDEAS)

    More about this item


    Optimal taxation; Monopoly power; Ramsey policy;

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

    NEP fields

    This paper has been announced in the following NEP Reports:


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpma:0511002. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.