Optimal Taxation with Imperfect Competition and Aggregate Returns to Specialization

Javier Coto-Martínez, Carlos Garriga () and Fernando Sánchez-Losada

Journal of the European Economic Association, 2007, vol. 5, issue 6, 1269-1299

Abstract: In this article 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 number 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. (JEL: H21, H30, E62) (c) 2007 by the European Economic Association.

Date: 2007
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