Cut the Human Capital Tax

The Republican Party has recently launched (or re-launched) a legislative initiative on the capital gains tax cut. As a fledgling debate on the issue has materialized, echoes of the past have emerged in yet another in a series of escalating polemics between the Democrats and the Republicans. In their pursuit of the capital gains tax cut, Republicans are again blindly attacked as the party of the rich. The Democrats, who generally oppose a capital gains tax cut and support an educational tax cut, are in turn rebuked by the other side as anti-business.

Possibly lost in the rising tide of rhetoric is the potential for much consensus between both parties. Both parties want to increase jobs. Both recognize the poor shape of the American job machine relative to its historical performance in past expansions and recessions. The best way to exploit this fertile common ground may be a recapitulation by the Clinton Administration of the educational tax cut as a retooled and newly-labeled 'human capital (gains) tax cut' complemented by other measures to increase its effectiveness.

Economic theory has caught up to the reality that basic and higher education plays an increasingly important role in the determination of incomes and livelihood. Human capital can be defined as the skills and technical knowledge workers possess. It is analogous to physical capital in that it is a complement to labor productivity and (by extenion) a complement to labor demand. It is also analogous to physical capital in that it represents the outcome of an investment: a costly expenditure in which benefits are spread out over a long period of time.

Those with high levels of education (or high levels of human capital) are generally the most attractive to firms. In recessions those with high levels of human capital are among the last laid off. They typically face the lowest unemployment rates and receive the highest wages. They are also beneficiaries of the highest growth rates in wages. Life for low-skilled workers, in comparison, will become increasingly precarious over time. In a future global economy where (among other things) a billion Chinese willing to do the same work for less than half the wage will flow into the labor market, living among the highly skilled will be the safest place for most Americans to be. The focus of each of the parties should be to channel more Americans into this dynamic and upwardly mobile segment of the labor pool.

Republicans have launched a worthy initiative. In their advocacy of a capital gains tax cut they propose to indirectly increase the number and enhance the quality to jobs by stimulating an increase in physical and financial investment. The argument is that by effectively making capital cheaper (or more valuable, depending on your perspective) the government will stimulate more capital formation and greater research and development. Subsequently, the short-term and long-term demand for labor will increase.

The GOP job-stimulating strategy represents a top-down approach: providing essentially greater tax savings to the business sector with the expectation that, by extension, this subsequent improvement in its financial performance will-to use an overused and much-maligned cliche (please forgive me)-trickle down to American workers. There's nothing wrong with that idea. It's laudable goal and a positive approach to job-stimulation. Though there's significant debate within academic and political circles about the magnitude of the benefits from such an approach, there's no denying that there are positive repercussions for employment generated by improving the financial performance of the private sector and making investment cheaper. In fact, the argument is somewhat obvious.

In this age diminishing resources, the best strategy may be to focus on the most direct approach to job stimulation. There are two basic aspects to the problem of job-stimulation. The first is the reluctance of the private sector (for many reasons stemming from strong competitive pressures, excessive regulation, etc.) to increase its use of labor relative to its historical demand for labor. The GOP proposes to address this aspect of the jobs problem through the mechanism of the capital gains tax cut.

The other part of the jobs problem is the lack of attractiveness of many segments businesses are generally attracted to providing high-wage, high-quality jobs in areas with the best infrastructure and to people with the best technical analytical and verbal skills. Many businesses regularly complain about not being able to find enough workers with the right basic skills. Too many Americans, they and many others claim, are undereducated and underskilled for the high-tech, high-wage, digital economy in which a growing percentage of market opportunities, both here and abroad, are available. Too many Americans are unattractive to the private sector due to deficiencies in the packages of education and job skills, or human capital, which they bring to the table.

By representing the educational tax cut as a human capital (gains) tax cut, the Clinton Administration can advocate their proposal and highlight its virtues in a way Republicans can better understand and appreciate. The Administration can also, in doing so, provide itself with a fresh intellectual foundation from which to better articulate and target this educational tax cut.

Human capital is the outcome of investment in education and job-increasing skills. The bulk of human capital is assumed not at the college level but at the grammar and high school level. It is also where the foundation is established for assimilating more developed and sophisticated higher verbal and mathematical skills later on in college. And, it is also the area which businesses claim are where the greatest educational deficiencies persist.

The biggest problem businesses face in providing jobs is finding workers with the basic skills typically attained at the grammer and high school levels. In that sense, the Clinton's Administration's initiative on what I will now call a human capital (gains) tax cut is best focused not at the college level, where merit financing exists and is plentiful, but at the grammar and public school level.

Of course the door is wide open on how to go about doing this: from direct grants of vouchers or tax deductions for families to pursue high quality grammar and high school education for themselves and their children (as many Republicans advocate) to government-initiated programs like Head Start. I leave this issue for others to debate although my general recommendation is for vouchers, which would essentially do at the high school and grammar school level what the Clinton's proposed job-training and educational tax cut would do at the college education and post-high school training levels.

College is not the problem, at least not in relative terms. The quality of American higher education is still among the highest in the world. Costs are rising but the growth in net costs to students is slowing. And, though financing is becoming increasingly difficult (and promises to become even more difficult with prospective cuts in federal student loans), financing from private and public sector sources is still bountiful and still widely available to qualified students in an era of rising private sector grants and intensifying competitiveness among colleges to attract qualified students with high financial aid packages.

Where the education deficiencies are greatest are at the levels below college education. The greatest problems are at the grammer and high school levels where the general quality of education remains inadequate relative to the economy's needs.

The best approach is typically the most direct one: the bottom-up approach, which is what a human capital gains tax cut represents. It stimulates job growth by increasing the attractiveness of American labor. Encouraging an increase in the amount of human capital will not only make American labor attractive to American firms but foreign firms as well, luring high-wage, high-quality jobs to this country from across the planet. It gives us more bang for the diminishing number of bucks at our government's disposal and also (to the extent that the credits or tax cuts are focused on stimulating more and better grammar and high school education) deals with the growing problems of economic inequality and inequality of opportunity in this country.

Rather than providing more income to the business sector (which is essentially what the capital gains tax cut and other related Republican measures would do by increasing tax savings), the best approach involves improving the attractiveness of American labor to both domestic and foreign businesses by giving Americans the power to rise to the occasion on their own. It is an approach consistent with both the Democratic and Republican themes of giving Americans more security and more control over their own lives and livelihoods rather than giving other institutions (the government or the corporate sector) the resources to provide it for them.

The optimal approach, of course, would be to save ideas about tax cuts for the next century as public officials and private citizens try to bring fiscal sanity to the federal government, but giving the nature of the current political dynamic, the offering of tax cuts seems unavoidable.

Given the inevitability of some kind of tax being offered, a 'human capital (gains) tax' cut is good economics and good politics. This approach may enhance the currently distracting, draining and harmfully digressive debate that appears taking shape between the GOP and the Democrats as both parties attempt to deal with what is surely first among the American public's concerns.

The writer is a senior economics concentrator affiliated with Cabot House