Monopoly power and corporate taxes

There has been a fair amount of debate about corporate taxes in the econ blogosphere. The debate was framed early on by a cute little exercise on Greg Mankiw’s blog which was supposed to  show that, in a small-open economy with perfect competition, a 1 dollar cut in capital taxes raises wage income by more than 1 dollar.

Paul Krugman and others have rightly pointed out that Mankiw’s toy example, its cuteness notwithstanding, provides little to no insight into the real policy debate now going on in the US, because (i) the US is not a small open economy and (ii) there is evidence that much of corporate profits are monopoly rents rather than returns to capital, which casts doubt on the relevance of perfect competition models.

Indeed, there’s a new paper documenting that mark-ups (difference between price and marginal costs) have increased in practically every industry in recent decades. The paper has not yet gone through peer review, so it’s probably wise not to jump to conclusions from it. Nevertheless, it’s useful to think about potential implications.

One of the basic results in public finance is that taxes on rents produce no deadweight loss. So if corporate profits are just monopoly rents, we can tax them away at zero social cost. Right?

Wrong.

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