Optimal Taxation of Capital Income in Models with Endogenous Fertility

steady state. □

By confirming our closed economy findings, we depart from the Chamley-
Judd prescription established for a small open economy by Correia (1996b),
Atkeson, Chari and Kehoe (1999), and Chari and Kehoe (1999). The ratio-
nale for the optimal tax structure just obtained is basically the same as the
one highlighted above for the closed economy.

Source-based regime

Under this international tax regime, the social planner optimum implies
that relationships (20) must still be satisfied. As the relationships Fk -δ = r*,
from (20c), and (1 — τk )(Fk — δ) = r*, from the condition of perfect capital
mobility, must be simultaneously satisfied, it is then requiered that τ_k =0.

This result can be summarized as follows:

Proposition 3 In a model with endogenous fertility and perfect capital mo-
bility, the optimal source-based taxation of capital income should be asymp-
totically zero.

Such a discovery departs from our previous results, but confirms what is
found in a small open economy when labor-leisure choices are elastic. The
mechanical motivation for this normative result stems from the fact that the
before-tax return on the domestic asset must equal the (untaxed) return on
net foreign assets. The intuitive motivation is, instead, as follows. As the
capital income tax rate does not affect fertility, labor taxation works in a
lump-sum fashion. It is then optimal to simply eliminate the tax distortion
affecting capital formation to replicate the first-best allocation.

20

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