From 1966 until 1973 the U.K. government levied the Selective Employment Tax which took the form of a weekly tax upon employees in service industries. By moving beyond competitive, constant returns models, the paper reconsiders the case for such industry-specific employment taxes. It is shown that the taxes are not justified by decreasing returns to scale even when profit taxation is non-optimal. In contrast, when imperfect competition is considered industry-specific income taxes become an integral part of an optimal tax system. Optimal tax rules are derived for an imperfectly competitive economy and the determinants of relative tax rates are investigated.