American Economic Review
ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)
Optimal Taxation and Market Power
American Economic Review
(pp. 119–63)
Abstract
Should optimal income taxation change when firms have market power? We analyze how the planner can optimally tax labor income of workers and profits of entrepreneurs. We derive optimal tax rates that depend on markups and identify four distinct components: the Mirrleesian incentive effect, the Pigouvian tax correction of the negative externality of market power, redistribution through altered factor prices, and reallocation of output toward the most productive firms. We quantify the optimal tax for the US economy and provide concrete proposals how to use income taxation to redistribute income while incentivizing production in the presence of market power.Citation
Eeckhout, Jan, Chunyang Fu, Wenjian Li, and Xi Weng. 2026. "Optimal Taxation and Market Power." American Economic Review 116 (1): 119–63. DOI: 10.1257/aer.20211445Additional Materials
JEL Classification
- D24 Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
- D31 Personal Income, Wealth, and Their Distributions
- D43 Market Structure, Pricing, and Design: Oligopoly and Other Forms of Market Imperfection
- H21 Taxation and Subsidies: Efficiency; Optimal Taxation
- H23 Taxation and Subsidies: Externalities; Redistributive Effects; Environmental Taxes and Subsidies
- H24 Personal Income and Other Nonbusiness Taxes and Subsidies; includes inheritance and gift taxes
- H25 Business Taxes and Subsidies including sales and value-added (VAT)