Efficient investment in children and implications for policy

Raising children is an important productive activity for a society since children’s out-comes depend on their parents ’ investments. This paper develops an intergenerational framework in which adult outcomes are determined by parental investment, analyzes Pareto efficient allocations, and derives implications for policy. There are two key frictions: first, parental altruism type is private information; second, it is impossible for society to mon-itor parental investment. The main characterization result is that in any ex post Pareto efficient allocation, in any generation, society should transfer extra resources to all poor parents. This implies all agents, including the poor, should live above a certain welfare level, independent of whether or not society cares about them. Regarding implementation, the paper first shows that if initial generation parents can sign exclusive contracts ex ante that legally bind all their descendants, then the resulting equilibrium allocation is Pareto efficient. Second, the paper considers a more realistic market structure in which parents cannot sign contracts binding their descendants. Under such a market structure, imple-menting any Pareto efficient allocation requires government intervention. A feature shared by all Pareto efficient income tax schedules is that income taxes of agents with currently low income are negative. ∗I am grateful to Narayana Kocherlakota and Chris Phelan for their valuable advice and encouragemen