Abstract:

This paper explores the implications of labor market power for optimal redistributive taxation. To do so, I extend the Mirrlees (1971) framework with endogenous wages, which are either (i) determined competitively, (ii) set by workers (through unions), or (iii) set by a monopsonistic firm. Three robust findings emerge. First, a non-linear tax on labor income can always restore efficiency. Second, market power restricts output, which provides a force for lower optimal taxes. Third, the optimal marginal tax is never positive at the top. Welfare under perfect competition is generally higher than with unions, but might be lower than with a monopsony.