Tax Reform and Human Capital Formation: Putting Education into the Equation
by J.D. Foster, Ph.D on 02/12/2002
23 Pages
It is clear that the more and better education somebody has, the greater are his or her prospects for economic success. One study showed that on average, lifetime earnings increase by about 10 percent with every additional year of education.
This return is not only personal, however, for studies show that higher education levels lead to overall economic growth for the nation. In fact, the economic return of educational investment is likely higher on the macro level than on the micro level. Society, democracy and the economy all profit from the education of the people. Complete tax reform should take away the current tax code’s many disincentives to human capital formation.
Fundamental tax reform promises improvements in economic performance because it makes the tax system far more neutral and therefore far less distorting of relative prices. The Flat Tax, for instance, allows first-year “ expensing” of all purchases of plant and equipment. Proposals for a national retail sales tax would exclude all purchases of plant and equipment from the sales tax base.
If the proper treatment of physical capital formation is expensing, it should follow that the proper treatment of human capital formation is also expensing. That is, all expenditures associated with improving an individual’s knowledge, skills, or techniques that could increase their earning power in the future should be immediately deductible from taxable income in any aggregative tax system like the Flat Tax, or excluded from tax in any transactional system like the national retail sales tax.
Even the current tax code contains several provisions for encouraging human capital formation. Though the basic intent behind these tax provisions is on the right track—to encourage human capital formation—they fall far short of a tax code that has no disincentives to education.
Other parts of the Internal Revenue Code, such as high marginal tax rates and progressive taxation, place a roadblock in front of people who want to improve their economic prosperity by acquiring extra skills, making a career change, or just by adapting to advances in technology.
In many ways, especially in the way of simplification, the Flat Tax and the national retail sales tax would be a major improvement over the current tax system. But as regards human capital formation, in their current form they actually would penalize education more than the current system does.
Fortunately, the remedy for this imbalance is simple. The Flat Tax should allow for expensing of educational costs. Likewise, the national retail sales tax should allow for exclusions of educational costs.
The equation of education and economic success has never been so pertinent. Virtually every industry and every occupation is experiencing a rapid infusion of new technologies.
At a time when the importance and the value to society of higher education is clear and increasing, and when these costs are rising rapidly, the punitive tax treatment of education seems highly unwise.
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