A Higher Corporate Profit Tax May Lead to a Welfare Improvement in a Fair Rate-of-Return Regulated Monopoly

Abstract

Well-known in the literature, a profit tax on an unregulated monopoly will not alter the optimal position of price and output. Given that unregulated monopoly is few and far in between, it has little practical relevance. This paper presents for the first time a paradox: A profit tax can indeed alter the optimal price and output and as such may lead to a welfare improvement in the case of a rate-of-return-regulated monopoly. In addition, it does not require extraneous assumptions of increasing returns to scale and/or very convex demand curve.