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Monopoly Power and Optimal Taxation of Labor Income

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  • Sheikh Tareq Selim

    (Cardiff University)

Abstract

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
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    Keywords

    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

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