Optimal Taxation of Capital Income in Models with Endogenous Fertility



is a bound on labor income taxation.4 The second change is represented by
the case in which the planner faces different constraints from the consumer
involving the capital stock; an example of this circumstance occurs when the
planner cannot distinguish between the income from two types of labor and
there are restrictions on the tax codes (namely, the two types of labor should
be equally taxed).

Erosa and Gervais (2002) provide another example in which the Chamley-
Judd result is inapplicable. They use a standard life-cycle growth model, in
which, as individuals have a labor-leisure choice in each period of their lives,
and hence the individual’s optimal consumption-work plan is almost never
constant, it is optimal almost always to tax consumption goods and labor
earnings at different rates over an individual’s lifetime. This goal can be
achieved by using capital and labor income taxes that vary with age. Judd
(2002), instead, obtains a negative capital income tax rate in a dynamic
model with monopolistic competition in the product market; in his view, a
capital subsidy can lighten the allocative inefficiency due to the monopoly
power of firms, thereby contrasting the reduction of capital and output im-
plied by the non-competitive equilibrium. By using an infinitely-lived model
of capital formation, Abel (2006) shows that if capital expenses could be
deducted immediately from taxable capital income, tax efficiency would pre-
scribe a positive tax on capital income and a zero tax on labor income. This
optimal tax structure, which is the opposite of the Chamley-Judd principle,
exactly replicates the first-best allocation obtainable with lump-sum taxa-
tion.

In this paper, we study the issue of the optimal capital income taxation in
neoclassical growth models with infinite horizons and elastic fertility choices,
i.e. endogenous population growth; the analysis considers closed and small
open economies. The hypothesis of endogenous fertility has been neglected
by the copious literature on efficient capital income taxation based on in-

4The case developed by Correia (1996a) can be viewed as another example of such a
change.



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