While the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. treatment of capital investment has been a topic of interest as of late, reviewing the tax treatment of human capital investment is also useful. Investments in worker training and education can increase productivity and economic output as growth in human capital accumulates, though the time horizon for these effects is longer than that of physical capital accumulation. Importantly, tax treatment can affect the decision to invest in human capital.
As we have written previously:
Currently, employers can deduct certain qualified education and training expenses for tax purposes, and certain qualified educational benefits are excludable from the taxable portion of employees’ wages. Generally, at the firm level, only education expenses which improve worker skills for their current positions are deductible. If the education would qualify workers for a new type of work, the expenses are not deductible. At the individual level, the tax treatment of educational expenses varies by income level and type of education.
These differences are important because tax treatment is relevant to human capital investment decisions, and human capital accumulation is a key driver of economic growth. Differing tax treatment can distort costs of investments and decision-making by firms and individuals.
The existing tax treatment of human capital investment is nonneutral and is an opportunity for reform. By denying the deductibility of certain types of worker training expenses, namely those that would qualify employees to perform new jobs, the tax code discourages businesses from making these investments. If instead businesses could deduct the cost of all types of training they choose to provide, the influence of the tax code on these business decisions would be removed. Expensing should not favor one type of capital over another.
Expensing for all types of capital contrasts with industry- or technology-specific expensing policies, which can distort incentives and lead to a less efficient allocation of resources as the tax code favors one industry or technology over another. Full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. of all types of investments avoids distorting decisions and prevents the tax code from picking winners and losers.
In addition to being neutral, allowing all investments to be deducted is generally simpler, more efficient, and easier to administer than creating investment-specific tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s. We can look at the current experience of individual education-related tax credits and the Research and Development (R&D) tax credit as a warning of the ineffectiveness of using credits:
Currently, individual taxpayers can choose from a complex swath of education-related provisions, which leads to suboptimal utilization. On the business side, the existing R&D credit is complex and difficult to parse, which provides an advantage to larger companies that have the resources to devote to legal barriers and leads to wasteful administrative expenditures.
Additional tax credits, either for individuals or businesses, would likely add to the complexity under current law rather than improve the tax treatment of these investments.
As lawmakers evaluate the tax treatment of investments in human and physical capital, it is important to prioritize changes that make the tax code simple, efficient, easy to administer, and neutral. Extending expensing treatment to all forms of capital investment, human and physical, would move the tax code in a more positive direction.
Stay informed on the tax policies impacting you.
Subscribe to get insights from our trusted experts delivered straight to your inbox.Subscribe