Optimal income taxation under monopolistic competition

Alexander Tarasov () and Robertas Zubrickas ()
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Alexander Tarasov: HSE University
Robertas Zubrickas: University of Bath

Economic Theory, 2023, vol. 76, issue 2, No 4, 495-523

Abstract: Abstract This paper is concerned with cross-dependencies between endogenous market structure and tax policy. We extend the Mirrlees (Rev Econ Stud 38:175–208, 1971) model of income taxation with a monopolistic competition framework with general additively separable consumer preferences. We show that quantity and variety distortions resulting from the market structure require adjustments to income tax policy, which also needs to be complemented with commodity or firm taxation to achieve the constrained social optimum. We calibrate the model and find that in policy design the failure to account for the market structure results in a welfare loss of 1.77%. Motivated by practical cases, we study a policy regime that is solely based on income taxation. We show that departures from the social optimum can be compensated by lower and less regressive income taxes and a smaller government compared to the regime with income and commodity taxes. We also examine the role of consumer preferences for policy outcomes and show that it is substantially amplified by an endogenous market structure.

Keywords: Tax policy; Monopolistic competition; Market distortion; Variety effect; Endogenous labor (search for similar items in EconPapers)
JEL-codes: D43 H21 L13 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (1)

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DOI: 10.1007/s00199-022-01463-z

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