Optimal Income Taxation under Monopolistic Competition

Alexander Tarasov and Robertas Zubrickas

No 9309, CESifo Working Paper Series from CESifo

Abstract: This paper is concerned with cross-dependencies between endogenous market structure and tax policy. We extend the Mirrlees (1971) model of income taxation with a monopolistic competition framework with general additively separable consumer preferences. We show that price and variety distortions resulting from the market structure imply that income tax policy needs to be complemented with commodity or firm taxation to achieve the constrained social optimum. We calibrate the model and find that, when choosing optimal tax policy, the failure to account for the market structure results in a welfare loss of 1:77 percent. Motivated by practical cases, we study a policy regime that is solely based on income taxation. Under this policy regime, departures from the social optimum can be compensated by lower and less regressive income taxes than those obtained under the regime with all forms of taxation. 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; variety effect; consumer preferences; endogenous labor (search for similar items in EconPapers)
JEL-codes: D43 H21 L13 (search for similar items in EconPapers)
Date: 2021
New Economics Papers: this item is included in nep-com, nep-isf, nep-pbe and nep-pub
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_9309

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