Optimal Income Taxation Under Monopolistic Competition

31 Pages Posted: 27 Sep 2021

See all articles by Alexander Tarasov

Alexander Tarasov

National Research University Higher School of Economics

Robertas Zubrickas

University of Bath

Date Written: 2021

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

JEL Classification: D430, H210, L130

Suggested Citation

Tarasov, Alexander and Zubrickas, Robertas, Optimal Income Taxation Under Monopolistic Competition (2021). CESifo Working Paper No. 9309, Available at SSRN: https://ssrn.com/abstract=3929203 or http://dx.doi.org/10.2139/ssrn.3929203

Alexander Tarasov (Contact Author)

National Research University Higher School of Economics ( email )

Myasnitskaya street, 20
Moscow, Moscow 119017
Russia

Robertas Zubrickas

University of Bath ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

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