IFS Working Paper (WP18/13)

Production efficiency and profit taxation

Date: 10 April 2018
Publisher: The IFS
DOI: 10.1920/wp.ifs.2018.W1813

Consider a simple general equilibrium economy with one representative consumer, a single competitive firm and the government. Suppose that the government has to finance public expenditures using linear consumption taxes and/or a lump-sum tax on profits redistributed to the consumer. We show that, if the tax rate on profits cannot exceed 100 percent, one cannot improve upon the second-best optimum of an economy with constant returns to scale by using a less efficient profit-generating decreasing returns to scale technology.