Market Power and Income Taxation

Summary

"Market Power and Income Taxation" (NBER Working Paper 25578, February 2019) by Harvard's Louis Kaplow asks whether significant market power — and the possibility that large profits are "tainted gains from monopoly or rent-seeking" — should change the design of optimal income taxation, and conversely whether concerns about inequality should toughen antitrust and other competition policies.[1] The paper's motivation sits squarely in the modern markups debate this wiki tracks elsewhere (its opening footnote cites the large-markup findings of De Loecker–Eeckhout–Unger and Hall, among others — see The Profit Paradox).

Key Argument

Kaplow builds a model with heterogeneous abilities (hence a concern for distribution), markups in multiple sectors, profit ownership that varies with income, endogenous labor supply, a nonlinear income tax, and an allowance for any share of profits to be recoveries of prior investment — including rent-seeking costs. Its headline results, from the paper's own abstract and conclusion:[1]

• Proportional markups with undissipated profits are neutral. In the model, "proportional markups with no profit dissipation have no effect on the economy" — eliminating them changes no feasible budget set and does not alter the optimal income tax problem.
• Nonproportional markups are judged against the average. A policy that reduces a particular markup "raises (lowers) welfare when it is higher (lower) than a weighted average of other markups."
• Standard prescriptions survive. "Perhaps surprisingly, the overall result is to leave largely intact" both "standard competition policy prescriptions that ignore distribution, labor supply distortion, and income taxation" and the familiar optimal-redistribution formulas derived in models without market power. Optimal policies "maximize consumer plus producer surplus" regardless of a reform's distributive effects, because a distribution-neutral income-tax adjustment can offset those effects.
• Isolation is the methodological sin. The conclusion stresses "how misleading it can be to examine industries in isolation" or to ignore the income tax when reasoning about rents and redistribution: interacting distortions can be largely offsetting rather than compounding.

Relevance to Georgism

The paper is a caution against a facile move: the presence of rents does not, by itself, overturn standard optimal-tax reasoning, and "taint" arguments for extra redistribution must be worked through a full general-equilibrium system in which the income tax can already neutralize distributive effects. At the same time, Kaplow's framework preserves the central geoist distinction — his welfare results turn on how much of profit is genuine surplus versus recovery of real resource costs (including rent-seeking dissipation), the same earned/unearned line that motivates taxing land rent directly. It is best read alongside the wiki's rent-seeking and monopoly-rent material as the careful public-finance treatment of when rent-directed policy actually raises welfare.

Bears On

• Concept: Rent-Seeking · Economic Rent
• Research: The Profit Paradox (Eeckhout) — the markup-evidence literature Kaplow's footnote 1 cites as the empirical backdrop

See Also

• Maria Alessandra Rossi, "Aggregate Market Power: Measurement, Drivers, and Macroeconomic Effects," Journal of Economic Surveys (2026), doi.org/10.1111/joes.70160 — a 2026 survey of the macro market-power literature whose abstract summarises the post-1980s pattern as stable median markups with rising upper-tail dispersion and reallocation toward a few high-markup firms, and calls the evidence linking market power to falling labour shares and rising inequality strong while productivity and investment effects are "more nuanced and non-monotonic" (open-access article; abstract only, full text not yet read)
• Rent-Seeking
• Economic Rent
• The Profit Paradox (Eeckhout)

Sources

1. Louis Kaplow (2019), "Market Power and Income Taxation," NBER Working Paper No. 25578, February 2019. NBER · Free PDF — used for the model setup (full text read in full, 2026-07-12), the proportional-markup neutrality result, the weighted-average markup-reform criterion, the "largely intact" conclusion about standard competition and optimal-tax prescriptions, and the conclusion's warning against analyzing industries in isolation (all quoted passages verified verbatim against the PDF).