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Taxation and Investment in Skills
OECD Centre for Tax Policy and
Administration
18 September 2012
Why do Taxes Matter?
• Economic returns influence individuals’ decisions to invest in education and training beyond compulsory schooling.
• By affecting the costs and financial benefits of education, taxes help shape the net return to human capital investments. This affects:
– The choice between working and studying
– The choice between alternative capital investments
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How do Taxes Matter?• Human capital investments costs directly influenced by:
– The deductibility or non-deductibility of tuition fees, registration fees, etc. from taxable income
– How foregone earnings would have been taxed
– The taxation of income used to pay for the costs of education
• Human capital investment returns directly influenced by:
– The taxation of the earnings premium resulting from the human capital investment.
– Tax relief provided upon completion of an educational program
– Tax incentives to attract foreign skilled workers
• In addition, there are indirect impacts:
– Influence of taxes on labour participation and migration
– Taxation of alternative capital investments
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Limitations of Tax Policy• An unfavourable tax treatment of human capital does
not preclude investment:
– Direct public subsidies may offset tax disincentives.
– Non-pecuniary benefits may motivate learning despite financial (e.g. tax) disincentives.
• A neutral (or favourable) taxation of human capital does
not guarantee investment:
– Other barriers may discourage learning. For example:
• Lack of access to credit and imperfect credit markets
• Risk and missing insurance markets
– The minimum return (earnings premium) required to break even may be unattainable (e.g. too close to retirement).
– Positive spillovers may result in suboptimal investment.
• However, the tax system can influence human capital investment decisions.
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What are Countries Doing? Key Trends in 20111
Tax Relief for the Direct Costs of Education and Training 2
PIT – higher education PIT – adult training VAT
OECD countries 11*+ India 16 29 + India+ South Africa
* Includes Spain, where tax relief is provided at the regional level in the Canary Islands
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Personal Tax Relief for the Sources of Finance of Education and Training 2
Scholarships Debt Savings Employer-financed
OECD countries 25 + India 13 + India 5 31 + India + South Africa
1 The 31 OECD countries considered here are: Australia, Austria, Belgium, Canada, Chile, the Czech Republic, Denmark, Estonia, Finland, Germany,
Greece, Hungary, Ireland, Israel, Italy, Japan, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, the Slovak Republic, Slovenia,
Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States.2 See details in the Appendix.
Tax Progressivity
PIT systems in all OECD countries have one or more structural elements that create progressivity, such as zero-rate bands, basic exemptions and graduated tax rate schedules
Tax Progressivity
• Tax progressivity = average tax rate increases with income
• Insofar as human capital translates into higher earnings, tax progressivity means that the earnings premium resulting from skills investments is taxed at a higher rate than foregone earnings during the study period.
• By reducing the benefit proportionately more than the cost of education, this creates a disincentive to study.
• Reducing the overall progressivity of the tax system could improve the financial incentive to invest in human capital but :
– Higher after-tax income inequality
– Possible revenue losses
– If revenue-neutral, work disincentives for lower income tax filers
– Windfall gains in the short-run for many high income tax filers6
Tax Relief for the Direct Costs of Education
• When the costs of human capital investments are not fully deductible for personal tax purposes, the tax system reduces the returns proportionately more than the costs, creating a disincentive to study.
– Important if tuition fees are high or subject to increase.
• Allowing tax filers to fully deduct the private direct costs of education (tuition fees, registration fees, etc.) could improve the incentive to invest in human capital.
– Turner (2011): US personal tax relief increased full-timeenrolment of 18-19 year olds in the first 2 years of college by 7%; enrolment up by 0.3 pctg. points for every USD 100 of tax relief.
– Lalumia (2010): US personal tax relief increased college enrolment of 33-41 year olds IF their educational attainment expectations not previously met.
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Other Targeted Tax Relief for Education
Examples: • Tax Relief for interest paid on student debt
• Tax-favoured education savings accounts
• Tax exemptions for scholarship and grant income, student employment income, etc.
Issues:• Tax advantage for particular sources of finance over
others (e.g. debt over savings)
• Tax relief for some students but not for others
• Tax relief not well targeted at sources of underinvestment (e.g. lack of access to credit)
• May result in double tax relief
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Education Institutions as Partners
Tax Administration:
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Verification of student status
Verification of costs claimed by students on tax return
Promotion of awareness of tax relief available to students
+ Potential role in tax relief delivery (e.g. advance payments)
Education Institutions as Partners (Cont’d)
Tax and Skills Policy:
• Institutions may capture part of the benefits of tax relief to students by:
– Raising tuition fees (Long, 2004)
– Reducing grant funding to students (Turner, 2012)
• Possible rationale:
– Perception that students don’t need tax relief
– Inadequate public funding to respond to growth in enrolment demand
– Institutions could potentially devote the captured resources to increase education quality or redistribute financial aid to students who are ineligible for tax relief
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Conclusions
• The tax system could potentially be relied upon to improve the incentive to learn through tax relief for the costs of education.
• Education finance policy and tax policy should not be developed in isolation
– Whole of government approach:
• Together, public funding for education and the tax treatment of human capital determine the net fiscal incentive to invest in human capital
– Education policy makers as liaison between education institutions and tax policy makers
– Partnership with education institutions necessary for tax policy to succeed
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THANK YOU
www.oecd.org/tax/taxpolicyanalysis/taxpolicyworkingpapers.htm
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Appendix – What are Countries Doing?
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Tax Relief for the Direct Costs of Education and Training
PIT – higher education
PIT – adult training VAT
Countries CAN; CZE; EST; GER; GRE; ITA;
NET; POR; SPA*; TUR; US; INDIA
AUS; AUT; BEL; CAN; FIN; GER; ISR; LUX; NET;
NOR; POR; SWE; SWI; TUR; UK; US
EU members; JAP; ISR; MEX; NOR;
SWI; TUR; INDIASOUTH AFRICA
* Tax relief is provided at the regional level in the Canary Islands
Personal Tax Relief for the Sources of Finance of Education and Training
Scholarships Debt Savings Employer-financed
Countries AUS; AUT; CAN; CZE; DNK; EST; FIN; GRE; HUN;
IRE; ISR; ITA; LUX; NET; NZL; NOR; POL; POR; SLK; SLV; SPA; SWE; SWI; US; INDIA
AUS#; BEL¤; CAN¤; DNK¤; FIN¤; HUN ; NOR¤#; POL# SWE¤; SPA¤*; US¤#; INDIA¤
CAN; GER; ISR; MEX;
US
All countries in this report:
AUS; AUT; BEL; CAN; CHL; CZE; DNK; EST; FIN; GER; GRE; HUN; IRE; ISR; ITA;
JAP; LUX; MEX; NET; NZL; NOR; POL; POR; SLK; SLV; SPA; SWE; SWI; TUR; US;
UK; INDIA; SOUTH AFRICA
# The value of deb t forgiveness is exempt from tax. The benefit from subsidized interest rates is exempt from tax. ¤ Tax relief for interest on
student debt. * This tax relief is provided at the regional level in Catalonia. In addition, in Italy, student loans from financial institutions are subject to a reduced financial transaction tax rate
References
• Lalumia, S. (2010), “Tax Preferences for Higher Education and Adult College Enrollment”, Department of Economics Working Papers, 2010-11, Department of Economics, Williams College, Williamstown.
• Long, B.T. (2004), “The Impact of Federal Tax Credits for Higher Education Expenses”, in C.M. Hoxby (ed.), College Choices: The Economics of Where to Go, When to Go, and How to Pay for It, University of Chicago Press.
• Torres, C. (2012), “Taxation and Investment in Skills,” OECD Taxation Working Papers, No. 13, OECD publishing.
• Turner, N. (2011), “The effect of tax-based federal student aid on college enrollment”, National Tax Journal, Vol. 64, pp. 839-61.
• Turner, N (2012). “Who Benefits from Student Aid? The Economic Incidence of Tax-Based Federal Student Aid,” Economics of Education Review, Vol.31, No. 4, pp. 463-481.
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