DP6416 Optimal Taxation and Monopsonistic Labour Market: Does Monopsony Justify the Minimum Wage?

Author(s): Pierre Cahuc , Guy Laroque

Publication Date: August 2007

Keyword(s): Minimum wage , Monopsony , Optimal taxation

JEL(s): H31 , J30 , J42

Programme Areas: Labour Economics , Public Policy

Link to this Page: www.cepr.org/pubs/dps/DP6416.asp.asp

We analyze optimal taxation in an economy with monopsonistic labour markets. The individuals, whose only decisions are whether to work, or not, have heterogeneous productivities and opportunity costs of work. Given its preferences for redistribution, the government, which does not observe the opportunity costs of work, chooses a tax scheme implementing the second best allocation. We compare the optima in the competitive and monopsonistic environments. We find that the government can always implement the second best allocation of the competitive economy in the monopsonistic environment. The optimal tax schedule comprises employment subsidies financed by taxes on profits. In this setup, there is no room for a minimum wage.