Optimal taxation in an endogenous fertility model with non-cooperative behavior

This study examines the optimal tax structure in a family decision model where spouses first collectively choose child quantity and then non-cooperatively decide child quality. In the model, both child quality and child quantity are suboptimally low due to the non-cooperative behavior of couples. Moreover, the model allows for both child quality and child quantity to have external effects on society. We show that under the optimal tax framework, income taxes, rather than child taxes/subsidies, play an effective role in correcting the low fertility level caused by spouses’ non-cooperative behavior. Whether a child tax or subsidy is optimal depends on the relative size of non-cooperation within couples and the external effects of children on society. Child taxes become optimal in the absence of an externality of children on society, regardless of the availability of a lump-sum tax.