Human Capital: One Investment Where America Is Way Ahead

The productivity of modern economies depends heavily on investments in the acquisition of knowledge and skills. Nevertheless, government statistics fail to consider expenditures on human capital as savings and investment.

Education, training on the job and in specialized institutes, and expenditures to improve health all contribute to human capital. Human capital is as much a part of the wealth of nations as are factories, housing, machinery, and other physical capital. In fact, economists estimate that human capital accounts for much more than half of all the wealth in the U.S. and other economically advanced nations.

While U.S. gross private investment in plants, equipment, and inventories has accounted for less than 15% of gross domestic product in recent years, the true investment rate that includes human capital is much higher. Spending on education alone in the U.S. is 7 1/2% of GDP, and Jacob Mincer of Columbia University estimates that spending for on-the-job and other training amounts to about 3% to 5%. At least one-fifth of the 14% of GDP spent on health should also be classified as investment in human capital, since it contributes to productivity and a longer working life.

FORGONE EARNINGS. Even these figures greatly understate the amounts spent on human capital, because they neglect the forgone earnings component of education and other investments. For example, a student who leaves a $40,000 job to spend two years getting an MBA forfeits $80,000 of earnings in order to advance his or her training. This is as much a cost of getting the MBA as the tuition. Indeed, forgone earnings can account for more of the cost, since B-school tuition averages, between public and private programs, less than $12,000 per year.

College and high school students and men and women enrolled in training programs also forgo considerable earnings when they are in school. Forgone earnings appear to account for more than half the total cost of high school and college education. Many students are tempted to drop out of school to get jobs because they are aware of how much income they must give up to continue their education. Free or reduced tuition alone does not provide income to cover living expenses.

The total earnings forgone by students in all types of schools and programs probably exceed 3% of GDP. Adding this to direct expenditures gives a total human capital investment in excess of 15% of GDP, which is greater than the physical capital share. Since investments in both types of capital amount to about 30% of GDP, America's commitment to future generations is far greater than usual investment statistics suggest. If other countries included spending on human capital, they too would show higher investment totals.

The U.S. tends to spend more than other nations on knowledge and high-level skills because its economy is the most advanced in the world. For example, a much larger fraction of American teenagers receive some college education than youths in most European countries. This is why international comparisons of investment that focus only on physical capital understate the efforts of the U.S. and other nations that spend a lot on knowledge--and overstate those of nations that emphasize plant and equipment at the expense of people.

SCHIZOPHRENIC APPROACH. Since investment in people is so important to growth and progress, one might expect considerable attention to its tax treatment. Yet the tax code takes a schizophrenic approach: On the one hand, forgone earnings--which can be considered investment--entirely avoid taxation, while on the other, tuition and school fees are treated as consumption and are usually not deductible as contributing to future skills and earnings. Since forgone earnings are such an important component of the total cost of human capital investments, these investments on the whole, perhaps unintentionally, receive more favorable tax treatment than do expenditures on plants and equipment.

The Republican Presidential candidates who advocate cuts in taxes on savings and investment have concentrated on physical capital. They have not considered how a flat income tax would affect incentives to invest in education and other types of human capital when some components of these investments are treated as consumption and others are entirely neglected.

No nation can thrive in the modern world without investing in its people. This is why national statistics on savings should include the cost of investing in human capital, and the debate over tax reform should deal with the effects on people's investments in themselves.