tertemporal optimizing models. One possible explanation for this lack of
analysis is the apparent similarity of infinitely-lived models based on endoge-
nous fertility with those incorporating elastic labor-leisure choices. From a
normative perspective on factor income taxation, this paper demonstrates
that a model with endogenous fertility is qualitatively non-equivalent to a
model with an elastic labor supply as their relative prescriptions on capital
income taxation differ substantially.
We discover that, in a closed economy, the optimal tax configuration
prescribes, in the limit, the subsidization of capital income and the taxation
of labor income.5 This result is to be attributed to a wealth effect in the
fertility choices; such an effect stems from the fact that the opportunity
cost of fertility, which in equilibrium must be equal to the marginal rate of
substitution of consumption for fertility, is given by the wage cost of child
rearing plus the stock of wealth (namely, the capital stock).
If an open economy facing perfect capital mobility is taken into ac-
count, two possible regimes for taxing capital income should be considered:
the residence-based or worldwide regime and the source-based or territorial
regime. According to the residence-based principle, the tax is levied on cap-
ital income of domestic residents regardless of the country where income is
originated; residence-based taxes represent taxes that accrue on nonhuman
wealth. Source-based capital income taxes, instead, are imposed on all cap-
ital income obtained in a particular jurisdiction regardless of the residence
country of savers; in this case, the location of capital, i.e. investment, is
subject to taxation.
When a financially integrated small open economy is considered, an en-
dogenous population growth implies that the efficient capital income taxa-
tion strictly depends on which regime is adopted. Differently from Correia
(1996b), Atkeson, Chari and Kehoe (1999), and Chari and Kehoe (1999),
5 The result of a negative capital income tax rate is not new, having also been ob-
tained by Correia (1996a), when the additional untaxed factor of production is Edgeworth
substitutable with capital, and Judd (2002).