Optimal Taxation of Capital Income in Models with Endogenous Fertility

consider the full expensing of wealth accumulation in order to eliminate the
intertemporal wealth tax wedge. In an open economy, the distortionary role
of capital taxation can be eliminated if the fiscal regime adopted is residence-
based. In this case, taxable income from wealth is given by r(K + B)- K
-δK - B . The flow budget constraint of consumers can be written as

k + b = (r* - n)(k + b)+[(1 ^{- τ}l)w^l + q - c].           (23)

(1 - τa)

The basic equations describing the agent’s optimal choices are

Un = (1 - τι)wT' + (1 - τa)(k + b),               (24a)

U_c

From equations (24), it is immediately clear that also in a small open

economy this type of nonhuman wealth taxation is non-distortionary if labor

is subsidized at a rate τl

In the case of a source-based capital tax regime, the Abel-Hall-Jorgenson
first-best proposal does not hold as the tax base is now given by income from
capital expensed from gross saving.

The following proposition summarizes our results

Proposition 5 In a small open economy with endogenous fertility and per-
fect capital mobility, optimal residence-based capital income taxation with
immediate expensing of wealth accumulation implies that the labor tax rate
should be negative to get nondistortionary capital taxation. A territorial capi-
tal income tax with saving expensing is not capable of reproducing the first-best
equilibrium.

23

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