Optimal Taxation of Capital Income in Models with Endogenous Fertility

Abstract

This paper studies the issue of the efficient taxation of capital income in intertemporal optimizing models with infinite horizons and endogenous population growth. We discover that, in the steady state, the optimal capital income tax is negative when the economy is closed. Instead, in a small open economy facing perfect capital mobility, the Chamley-Judd result of a zero tax rate is obtained if capital taxation is source-based; otherwise, income from wealth should be subsidized if taxation is residence-based. Moreover, we find that in our setup, taxing capital income with immediate expensing of capital expenditure may replicate the first-best equilibrium when labor is subsidized. Our findings, which depart substantially from those obtained in representative agent models with an endogenous labor supply, are to be ascribed to a wealth effect in the fertility choices that directly affects the pseudo-welfare function of the social planner.

Keywords: factor income taxes, Second-best analysis, endogenous population growth, Capital formation

JEL Classification: E62, H22, J22, O41