Optimal Taxation of Capital Income in Models with Endogenous Fertility

Optimal Taxation of Capital Income in
Models with Endogenous Fertility

Alberto Petrucci*     LUISS University

Aprile 2007

Abstract

This paper studies the issue of the efficient taxation of capital in-
come in intertemporal optimizing models with infinite horizons and
endogenous population growth. We discover that, in the steady state,
the optimal capital income tax is negative when the economy is closed.
Instead, in a small open economy facing perfect capital mobility, the
Chamley-Judd result of a zero tax rate is obtained if capital taxation
is source-based; otherwise, income from wealth should be subsidized
if taxation is residence-based. Moreover, we find that in our setup,
taxing capital income with immediate expensing of capital expendi-
ture may replicate the first-best equilibrium when labor is subsidized.
Our findings, which depart substantially from those obtained in rep-
resentative agent models with an endogenous labor supply, are to be
ascribed to a wealth effect in the fertility choices that directly affects
the pseudo-welfare function of the social planner.

JEL classification: E62; H22; J22; O41.

Keywords : Factor Income Taxes; Second-best Analysis; Endoge-
nous Population Growth; Capital Formation.

*I am grateful to Pietro Reichlin and Marco Scarsini for fruitful discussions. Address:
LUISS University, Department of Economics, Via Tommasini 1, Rome, Italy, 00162. Tel.
+39 06 8650 6737-6770; Fax +39 06 8650 6513; E-mail: [email protected].

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