Optimal Taxation and Market Power

85 Pages Posted: 24 May 2021

See all articles by Jan Eeckhout

Jan Eeckhout

University College London - Department of Economics

chunyang fu

Chinese Academy of Sciences (CAS)

Xi Weng

Peking University

Wenjian Li

Zhejiang University

Date Written: April 1, 2021


Should optimal income taxation change when firms have market power? The recent rise of market power has led to an increase in income inequality and a deterioration in efficiency and welfare. We analyze how the planner can optimally set taxes on labor income of workers and on the profits of entrepreneurs to induce a constrained efficient allocation. Our results show that optimal taxation in the presence of market power can substantially increase welfare, but it also highlights the severe constraints that the Planner faces to correct the negative externality from market power, using the income tax as a Pigouvian taxes. Pigouvian taxes compete with Mirrleesian incentive concerns, which generally leads to opposing forces. Overall, we find that due to incentive concerns, market power tends to lower marginal tax rates on workers, whereas it increases the marginal tax rate on entrepreneurs.

JEL Classification: D3, D4, J41

Suggested Citation

Eeckhout, Jan and fu, chunyang and Weng, Xi and Li, Wenjian, Optimal Taxation and Market Power (April 1, 2021). CEPR Discussion Paper No. DP16011, Available at SSRN: https://ssrn.com/abstract=3846096

Jan Eeckhout (Contact Author)

University College London - Department of Economics ( email )

30 Gordon Street
London WC1E 6BT, WC1H 0AX
United Kingdom

Chunyang Fu

Chinese Academy of Sciences (CAS) ( email )

52 Sanlihe Rd.
Datun Road, Anwai
Beijing, Xicheng District 100864

Xi Weng

Peking University ( email )

Beijing, 100871

Wenjian Li

Zhejiang University ( email )

38 Zheda Road
Hangzhou, Zhejiang 310058

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