Optimal Income Taxation with Endogenous Prices

43 Pages Posted: 6 Sep 2019

See all articles by Alexey Kushnir

Alexey Kushnir

Carnegie Mellon University - David A. Tepper School of Business

Robertas Zubrickas

University of Bath

Date Written: August 1, 2019

Abstract

We study an optimal income taxation problem in a Mirrleesian setting with endogenous product prices and positive firm profits. When firm profits are progressively distributed among agents, we show that the public authority uses the price level as a redistributive tool favoring lower prices in competitive markets. This leads to higher marginal taxes in the optimum. Using simulations, we show that this price effect adds around 4 percentage points to marginal income tax rates. In oligopolistic markets, market power adds an additional non-competitive component to the price effect that exerts downward pressure on optimal tax rates. Using simulations, we show that, as the market structure varies, changes in non-competitive and redistributive components almost cancel each other out for medium and high degrees of equity concerns. Thus, optimal income tax policy remains stable across various market structures. We also analyze how commodity and profit taxation influence the price and non-competitive effects.

Keywords: optimal income taxation, endogenous price, competitive market, conjectural variation, oligopolistic market

JEL Classification: H21, H23, D43

Suggested Citation

Kushnir, Alexey I. and Zubrickas, Robertas, Optimal Income Taxation with Endogenous Prices (August 1, 2019). Available at SSRN: https://ssrn.com/abstract=3445132 or http://dx.doi.org/10.2139/ssrn.3445132

Alexey I. Kushnir (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

Robertas Zubrickas

University of Bath ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

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