Optimal Taxation of Capital Income in Models with Endogenous Fertility

where the Chamley-Judd principle is confirmed under both international
regimes of wealth income taxation, our key findings involve either subsidizing
capital, if taxation is residence-based, or avoiding the distortion of capital
formation, if taxation responds to a source-based criterion; a fiscal levy on
labor income, irrespective of the taxation regime, should be imposed.

Finally, we examine, in the context of endogenous fertility, the proposal
of capital income taxation combined with an immediate expensing of capital
expenditure as proposed by Hall and Jorgenson (1967), and studied in a
general equilibrium context by Abel (2006). In a closed economy, the first-
best equilibrium is replicated if the tax on capital is accompanied by a labor
subsidy. In the open economy analysis, the closed economy findings are
reiterated if gross saving is expensed from taxable wealth income when the
residence-based regime is adopted. Our results stand in sharp contrast with
those obtained by Abel (2006) in a closed economy, where efficiency requires
to tax capital and free labor from taxation.

The paper is structured as follows. Section 2 presents the closed economy
model with endogenous fertility choices, and analyzes its positive and norma-
tive implications for factor income taxation. Section 3 extends the previous
analysis to a small open economy facing perfect capital mobility. Section 4
discusses the proposal of expensing capital expenditure from taxable income
in the case of endogenous population growth. Section 5 concludes.

2Closedeconomy

2.1 The setup

Consider a real closed economy peopled by immortal consumers, who de-
cide on consumption, fertility, and saving on an intertemporal basis.⁶ The
representative consumer of this economy maximizes the following integral

⁶The model employed here builds on Razin and Ben-Zion (1973), Palivos (1995) and
Barro and Sala-i-Martin (2003, ch. 9).

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