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Optimal taxation with monopolistic competition

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Abstract

This paper studies optimal taxation in a Dixit–Stiglitz model of monopolistic competition. In this setting, taxes may be used as an instrument to offset distortions caused by producer markups. Since markups tend to be higher in industries where firms face less elastic demand, tax rates will be pushed lower in these industries. This tends to work against the familiar inverse elasticities intuition associated with the Ramsey tax rule. However, a key feature of the model is that the Ramsey rule responds to the industry demand curve (Chamberlin’s DD) while the monopolistic markup is a response to the demand curve faced by firms (Chamberlin’s dd). Hence, the elasticities of both these curves influence the optimal tax rate, but in opposite directions.

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Authors and Affiliations

  1. Economics Department, University of Durham, 23-26 Old Elvet, Durham, DH1 3HY, UK

    Leslie J. Reinhorn

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  1. Leslie J. Reinhorn
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Correspondence to Leslie J. Reinhorn.

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Reinhorn, L.J. Optimal taxation with monopolistic competition. Int Tax Public Finance 19, 216–236 (2012). https://doi.org/10.1007/s10797-011-9182-z

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  • DOI: https://doi.org/10.1007/s10797-011-9182-z

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