In short "yes" I feel you should be able to kill kids when it fits in with the game. Truthfully the first time *I* ran into the issue was with Silent Hill 2 and the game company basically backed down screaming when they were criticized for all of the evil-skinned child bashing in the demo. The evil children having been a big part of Silent Hill 1 and responsible for perhaps the most creepy game opening EVER. Whether this is the first example or not, it's when I seriously started paying attention to the issue.
Simply put killing children has been done in many games, the one above (sort of, the children are already dead), Fallout, and others. If your doing an intentionally dark 'M' rated game where it fits, then go for it.
I will also point out that due to all of the african child-fighters (you see on the news), the Hitler Youth, and things like Saddam's lion cubs, killing children might also be appropriate in various military games as well within specific situations. For example if your doing a game where your attacking Berlin, not portraying the Volkssturm and the Hitler Youth being involved prevents it from ever truely being realistic. A real war similator (WW II or otherwise) would include a decent amount of moral ambiguity .
I think the issue is largely one of the game industry lacking the guts to fight against censorship, both private and govermental. Simply put they have long ago ceased to be serious artists/writers, and if we buy the games in censored form, why should they bother to invest the resources in fighting?
The no child-killing thing bugs me not in of itself (I don't usually play war simulators, and honestly in most games I take the good path given the option) but as part of the overall issues about sex, violence, and other content in video games. Especially in some generes I *DO* play like horror games where all of that stuff is very appropriate.