Rising markups and optimal redistributive taxation

Abstract

This study explores the implications of rising markups for optimal Mirrleesian income and profit taxation. Using a stylized model with two individuals, the main forces shaping welfare-optimal policies are analytically characterized. Although a higher profit tax has redistributive benefits, it adversely affects market competition, leading to a greater equilibrium cost-of-living. Rising markups directly contribute to a decline in optimal marginal taxes on labor income. The optimal policy response to higher markups includes increasingly relying on the profit tax to fund redistribution. Declining optimal marginal income taxes assists the redistributive function of the profit tax by contributing to the expansion of the profit tax base. This response alone considerably increases the equilibrium cost-of-living. Nevertheless, a majority of the individuals become better off with the optimal policy. If it is not possible to tax profits optimally, due, for example, to profit shifting, increasing redistribution via income taxes is not optimal; every individual is worse off relative to the scenario with optimal profit taxation.

Monopolistic competition, rising markups, and optimal taxation of participation

“…The optimal unemployment benefit slightly increases from 3425 US dollars with $${\phi }_{1}=0.521$$ to 3906 US dollars with $${\phi }_{2}=0.968$$. This outcome is similar to that of Gürer (2021). Intuitively, once the profit tax rate is inoperative and not allowed to increase along with higher fixed costs/markups, a strong reduction in optimal marginal income taxes would reduce government revenue requiring a decline in both income transfers to the working poor and the unemployed.…”

“…These findings resonate with Gürer (2021) and Eeckhout et al (2021). In particular, Gürer (2021) shows in a similar setting that the increase in the optimal profit tax rate is driven by a rise in the denominator of Equation (16), the social value of taxable profits. Simultaneously, the optimal marginal income taxes decrease with the purposes of incentivizing labor supply and amplifying the amount of taxable profits.…”

“…The aforementioned stylized facts have triggered a wave of papers that study the optimal redistributive tax policy under rising market power which are discussed further in Section 1.1. Most relatedly, Eeckhout et al (2021) and Gürer (2021) show that, in response to higher fixed costs and markups, the optimal strategy of a utilitarian government comprises reducing marginal income taxes and increasing the taxes on profits. While this literature focuses on the taxation of intensive margin labor supply and profits, the present study incorporates the extensive margin decisions of the workers and puts a particular emphasis on the size of unemployment benefits and participation taxes.…”

Pro-rich Inflation and Optimal Income Taxation

“…Price increases may also feed into higher profits and income, which is not discussed in this study. Gürer (2021) shows that higher prices, if triggered by higher markups, justify greater corporate taxes and lower income taxes. At the same time, Gürer (2021) abstract from asymmetric price changes, which is the main contribution of this study.…”

Optimal income taxation under monopolistic competition

“…The externalities of adverse selection and moral hazard in labor markets and their effects on tax policy are studied by Golosov and Tsyvinski (2007), Chetty and Saez (2010), and Stantcheva (2014, 2017. Tax policy can create pecuniary externalities with implications for real wages due to its effects on aggregate demand and equilibrium prices (da Costa and Maestri 2019; Kushnir and Zubrickas 2019;Eeckhout et al 2021;Gürer 2021;Kaplow 2021). The distinctive feature of the present paper is its consideration of the variety or market entry effect under general additively separable consumer preferences that may offset the price effect of pecuniary externalities in tax policy design.…”