Optimal Taxation and Monopsonistic Labor Market: Does Monopsony Justify the Minimum Wage?
26 Pages Posted: 17 Aug 2007
Date Written: July 2007
We analyze optimal taxation in an economy with monopsonistic labor markets. The individuals, whose only decisions are whether to work, or not, have heterogeneous productivities and opportunity costs of work. Given its preferences for redistribution, the government, which does not observe the opportunity costs of work, chooses a tax scheme implementing the second best allocation. We compare the optima in the competitive and monopsonistic environments. We find that the government can always implement the second best allocation of the competitive economy in the monopsonistic environment. The optimal tax schedule comprises employment subsidies financed by taxes on profits. In this setup, there is no room for a minimum wage.
Keywords: minimum wage, optimal taxation, monopsony
JEL Classification: H31, J30, J42
Suggested Citation: Suggested Citation