Abstract: 

I study the optimal taxation of families in an environment in which (i) characteristics of a family, labor productivity anddesire for children, are only observable by the family, and (ii)child-rearing requires both goods and parental time. Potentialparents simultaneously decide labor income and number of children. Thegovernment uses information on family income and family size toconstruct an optimal tax system via a combination of an income taxschedule with child tax credits. I observe that the parental time andthe cost of goods involved in child-rearing have distinct impacts onthe shape of optimal child tax credits. As a quantitative analysis, I calibrate my model to the US data and show that child-rearing coststranslate into a pattern of optimal credits that is U-shaped inincome. In particular, the credits are decreasing in the first threequarters of the income distribution and increasing afterwards. In addition, the credits are decreasing by family size owing to economiesof scale in the impact of child-rearing costs. For median-incomefamilies, the credit for the second child equals 64% of the credit forthe first child. I find that the optimal tax schedule generates awelfare gain equal to 1.3% of aggregate consumption.

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