Imperfect Competition and Optimal Taxation

This paper provides optimal labour and dividend income taxation in a general equilibrium model with oligopolistic competition and endogenous firms' entry. In the long run the optimal dividend income tax corrects for inefficient entry. The dividend income tax depends on the form of competition and the nature of the sunk entry costs. In particular, it is higher in market structures characterized by competition in quantities rather than those characterized by price competition. Oligopolistic competition leads to an endogenous countercyclical price markup. As a result, offsetting the distortions over the business cycle requires deviations from full tax smoothing.