Reforming the Taxation of Human Capital: A Modest Proposal

Paul David

Working Papers from Stanford University, Department of Economics

Abstract: Finel Revision October 2002

A new scheme of personal income tax reform would eliminate the inefficiencies arising from differences in the tax treatment of investments in intangible human capital and other types of capital formation. It also would offset the exacerbation of those distortions caused by progressive taxation, without requiring abandonment of the latter principle. The proposed incremental reform of the personal income tax regime would permit full deductibility of private costs of education and training, but defer the exercise of the deduction credits. The novel instrument for achieving these objectives is an individually held, non-transferable asset: an untaxed, interest-bearing educational (expense) deduction account -- christened the “UIBEDA,” and pronounced: “we-bedda.” Under plausibly realistic assumptions about the time profile of education-associated earnings differentials, and the progressiveness of tax rate schedules, it is feasible for the Treasury adopting such a scheme to satisfy an intertemporal balanced budget constraint, while in effect acting as a financial intermediary in the market for human capital investments. The UIBEDA scheme facilitates shifting from direct educational subsidies to the use of publicly subsidized student loans, and also can be readily extended to promote selective immigration of workers who have incurred indebtedness for human capital investments abroad.

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