TAXES AND SKILLS
LAC Forum Presentation, 10/06/2014
Bert Brys
OECD Centre for Tax Policy and Administration
Overview
1. Introduction & Motivation
2. Methodology
3. Results
2
Background
• CTPA’s Skills Indicators:
• Examine the after-tax costs and returns of skills investments for
workers,
• Examine costs and benefits for governments from skills
subsidies.
• Big literature on tax and capital – tax rates on physical capital
have fallen across the OECD. But what about human capital? Are
we getting the mix right between physical and human capital?
• Also literature on tax expenditures – how can policymakers
evaluate the equity/efficiency implications of credits, deductions,
and exemptions? New indicators help analyse tax expenditures
versus direct spending as a way to increase skills investment.
• Increasing OECD work on inclusive growth – new indicators
highlight the relationship between progressivity and skills
3
CTPAs Tax and Skills Work
Inputs
Survey on Tax
and Skills
Taxing Wages
Education at a
Glance
Tax and Skills
Model
New
Indicators
Outputs
Potential
Future Uses
Breakeven
Earnings
Increment
Marginal
Effective
Tax Rate
on Skills
Average
Effective
Tax Rate
on Skills
Skills Country
Reviews
(ongoing)
Taxing Wages &
Skills, Savings
Marginal
Returns
to Costs
Ratio
Average
Returns
to Costs
Ratio
Tax and Skills
Policy Study
(2015)
Economic
Surveys
Financing of
Education Work/
Education at a Glance
4
Full Set of New Indicators
Earning Data Used
BEI – Calculated
Breakeven Earnings
Level (just enough
earnings to pay for
Education)
Measure of the
Effect of Tax Code
Marginal Effective
Tax Rate on Skills
(METR)
Measure of Returns
for Government
Marginal Returns to Cost
Ratio (MRCR)
Earnings Increase
Average Effective Tax Average Returns to Cost
based on Labour
Rate on Skills
Ratio (ARCR)
Market data from EAG (AETR)
5
Apportioning Returns and Costs
Costs and Returns of skills investments shared between individuals
(students/ workers) and the government (and firms).
• Direct Costs:
 Individual pays direct costs, tuition fees, net of scholarships & tax
expenditures,
 Government pays for education institutions, some scholarship payments,
costs of tax expenditures.
• Lost Earnings (often much larger than Direct Costs):
 Individual pays in lost (net of tax) earnings while studying/ up-skilling,
 Government pays in lost taxes while studying/ up-skilling.
• Returns:
 Individual earns higher after-tax wages,
 Government gets higher tax revenue.
The tax system apportions the costs and returns between
government and the individuals who invest in skills.
6
How can the ETR/RCR data be used?
• Goal:
• Examine how the whole policy mix affects the decision
to invest in human capital: tax rates, tax expenditures,
educational funding, and direct costs.
• A wide range of topics can be analysed:
• Individual Incentives:
• If a worker decides to get a Master’s degree, how much will
she need to earn to recoup the costs of her investment?
• Do skills tax expenditures really impact the financial
incentives of workers, or are they dwarfed by other
considerations such as lost earnings? Are they more or less
effective than direct spending?
7
How can the ETR/RCR data be used?
• Goal:
• Examine how the whole policy mix affects the decision
to invest in human capital: tax rates, tax expenditures,
educational funding, and direct costs.
• A wide range of topics can be analysed.
• Government Incentives:
• How much of state spending on education and training is
returned to the government in the form of future tax
revenue? How much is captured by the worker?
• How much of the costs of lifelong learning are borne by the
worker? How much are borne by the government?
• If the government decides to raise tuition fees, can it use
the tax code to compensate workers’ incentives to upskill?
8
Overview
1. Introduction & Motivation
2. Methodology
3. Results
9
Overview
1. Introduction & Motivation
2. Methodology
a.
b.
c.
d.
e.
Breakeven Earnings Increment (BEI)
Marginal Effective Tax Rates (METR)
Average Effective Tax Rates (AETR)
Marginal Returns to Costs Ratio (MRCR)
Average Returns to Costs Ratio (ARCR)
3. Results
10
Breakeven Earnings Increment
• We calculate the costs of a marginal skill investment –
factoring in costs of tuition, lost earnings and tax credits &
deductions for costs of education.
• We then calculate the Earnings Increment necessary to
pay for the investment over the years left working.
• How much does income need to rise to break-even?
• Factor in the effects of the tax code – higher earnings
needs to pay for higher tax brackets,
• Tax progressivity can lead to higher tax rates on skills.
• Calculate the EI for the marginal workers – who is just
indifferent between investing and not.
• Technically, we calculate the income after education such
that the NPV of education is equal to zero.
11
BEI Methodology – No Education
• We consider a worker
contemplating a
period of education.
• We assume that
without education,
her earnings remain
constant.
12
BEI Methodology – Lost Earnings
• The main costs of
education come in the
form of lost earnings.
• These earnings are
often offset by lower
taxes.
• Sometimes there are
special tax provisions
for students.
13
BEI Methodology – Direct Costs
• There are also
significant direct
costs.
• The earnings after
education must rise to
make the overall
investment
worthwhile.
14
BEI Methodology – Recouping Costs
• The worker must,
over the remainder of
her life, earn extra to
earn back her costs of
education.
15
BEI Methodology – Recouping Opp. Cost
• She must also earn
the returns on some
alternative capital
investment – say,
shares or bonds she
could have bought
with her education
spending.
16
BEI Methodology – The Tax Wedge
• In addition, she may
owe some extra taxes
because she is now
earning more
(because of tax
progressivity).
• But this effect could
be offset by
deductions, credits
etc. for the cost of
studying.
17
Endogeneity of Income After Education
As the tax code takes more
income after education,
more must be earned to
break even.
Tax Paid After
Education
Earnings after
education
18
Overview
1. Introduction & Motivation
2. Methodology
a.
b.
c.
d.
e.
Breakeven Earnings Increment (BEI)
Marginal Effective Tax Rates (METR)
Average Effective Tax Rates (AETR)
Marginal Returns to Costs Ratio (MRCR)
Average Returns to Costs Ratio (ARCR)
3. Results
19
Calculating the METR
• We calculate the Earnings Increment with taxes - EI(Tax) and without taxes EI(No Tax).
• Then, the Marginal Effect Tax Rate on Skills is simply
the tax wedge as a share of the Earnings Increment.
BEI Tax  BEI NoTax
METR 
BEI Tax
• The Breakeven Earnings Increment (BEI) also adds value as
an indicator, when compared to labour market data on what
the earnings premium in the labour market really is.
• Is the Breakeven Earnings Increment, post-tax, actually
available to the student in the labour market?
• Does it pay to go to school?
20
METR Methodology – The BEI and the ETR
• In other words, the
METR is effectively
the Tax Wedge as a
fraction of BEI.
• Or, the answer to
the question: “How
much of the extra
earnings needed to
breakeven on a
skills investment is
because of taxation”
21
Overview
1. Introduction & Motivation
2. Methodology
a.
b.
c.
d.
e.
Breakeven Earnings Increment (BEI)
Marginal Effective Tax Rates (METR)
Average Effective Tax Rates (AETR)
Marginal Returns to Costs Ratio (MRCR)
Average Returns to Costs Ratio (ARCR)
3. Results
22
AETR Methodology
• Marginal Effective Tax Rate on Skills examines the effect of the tax
code when the student earns just enough to breakeven on a skills
investment.
• Average Effective Tax Rate on Skills examines the effect of the tax
code when the student earns what is available in the labour market.
NPVTax  NPVNoTax
AETR 
EI Tax
The formula used is the difference between the net present value of
education (at a given non-breakeven earnings level) with and
without taxes.
• This is expressed as a share of the discounted extra earnings after
education.
• We use OECD labour market data to calculate the average returns
to the student.
23
AETR Methodology
• Usually, the returns to
education are much
higher than the
breakeven earnings
level.
• As students earn
more, they get pushed
into higher tax
brackets.
• Therefore, usually
AETR>METR.
• A better indication of
the overall impact of
taxes on skills.
24
Overview
1. Introduction & Motivation
2. Methodology
a.
b.
c.
d.
e.
Breakeven Earnings Increment (BEI)
Marginal Effective Tax Rates (METR)
Average Effective Tax Rates (AETR)
Marginal Returns to Costs Ratio (MRCR)
Average Returns to Costs Ratio (ARCR)
3. Results
25
Marginal Returns to Costs Ratio
• Just as there are costs and benefits to education for the
student, there are also costs and benefits for the
government.
• Calculating these – the NPV of education with respect to the
government - gives us a picture of the ‘returns to education’
for the government in the form of future tax revenue.
• Provides with an indicator of the financial costs and benefits
for the government.
• Does not include non-tax benefits from education for the
government e.g. higher growth, lower unemployment, social
benefits etc.
26
Who Bears the Costs of Upskilling
Costs
Benefits
Direct (private & public) training costs
Total
Foregone earnings
Higher earnings
after upskilling
Direct Costs
Private
(Worker)
+ Lost post-tax earnings during upskilling
- Offset by scholarship Income
Higher post-tax
earnings after
upskilling
- Offset by education tax breaks
Direct educational spending
Public
(Government)
+ Lost tax revenue during upskilling
+ Cost of scholarships
Higher tax
revenue after
upskilling
+ Cost of educational tax breaks
27
Calculating the MRCR
• The MRCR can be expressed as a ‘ratio of ratios’ of the
government and private share of the returns and costs to
education:
Returns
Government
Return Worker
MRCR 
Costs Government
Costs Worker
• If the government pays a larger share of costs than the share
of the returns it receives, then MRCR < 1.
• If the government receives a larger share of returns than the
share of the costs it pays, then MRCR >1.
28
Marginal Returns to Cost Ratio
• MRCR higher than 1 -->
• NPV of costs of upskilling are lower than NPV of returns -->
• Further spending on training will yield back its cost in tax
revenue.
• MRCR lower than 1-->
• NPV of costs of upskilling are higher than NPV of returns -->
• Further spending on training will not yield back its cost in
future tax revenue.
29
Overview
1. Introduction & Motivation
2. Methodology
a.
b.
c.
d.
e.
Breakeven Earnings Increment (BEI)
Marginal Effective Tax Rates (METR)
Average Effective Tax Rates (AETR)
Marginal Returns to Costs Ratio (MRCR)
Average Returns to Costs Ratio (ARCR)
3. Results
30
ARCR Methodology
• The METR and AETR examined the effect of the tax code on skills
incentives for an average or marginal student respectively.
• Similarly, there is an equivalent ARCR to the MRCR.
• The MRCR examines the returns to costs ratio for the
government from educating a student who just breaks even on a
skills investment.
• The ARCR examines the returns to costs ratio for the government
from educating a student who earns an average returns to the
skills investment.
• Again, OECD labour market data are used to calculate returns to
the student.
31
Overview
1. Introduction & Motivation
2. Methodology
3. Results
32
Four Sample Cases
College
Education
Graduate
Education
In-Work
Training
Lifelong
Learning
Age
17
27
32
50
Length of
Education
4 Years
1 Year
3 Months
1 Year
Earnings
with No
Education
70% AW
100% AW
100% AW
100% AW
Earnings
During
Education
25% AW
25% AW
25% AW
25% AW
Job-Related
No
No
Yes
No
Scholarship
Income
Yes
Yes
No
Yes
33
Limitations and Caveats
• Technical Limitations – can all be relaxed:
• Simplified data on costs and scholarships (will greatly
improve with next round of education data),
• No accounting for many financing aspects; student debt,
parental spending, firm spending, student credit
constraints,
• No accounting for later labour market consequences of
skill investments: changes in unemployment probabilities,
changes in participation probabilities,
• No accounting for how increased skills may result in higher
rates of increase in wages (in addition to rises in in wage
levels).
34
Limitations and Caveats
• Limited set of returns modelled – harder to relax
accurately:
• No measurement of non-fiscal positive economic
effects of skills investments: on productivity, on growth,
on employment,
• No measurement of positive social effects of skills
investments: on health, on crime, on job quality, on wellbeing,
• No measurement of some positive exchequer effects:
higher indirect taxes from higher spending, lower social
welfare payments.
• Our model almost certainly underestimates both the
public and private benefits to education.
35
University education more than breaks even
for the average student
• Compare the breakeven
earnings increment to the
average college premium
available in the labour
market.
• In all countries college is a
financially worthwhile
investment for the average
student in the model.
• Where existing skill levels
are low, the returns to
skills are far higher than
the BEI.
Data are for a 17-year-old single taxpayer with no children, who undertakes a 4 year course of
non-job-related education, earning 25% of the average wage during schooling. They earn
70% of the average wage in the absence of schooling. Data for Mexico and the United States
are omitted du to data limitations.
• Low BEIs driven by low
lost earnings for college
students and high levels of
scholarship income.
36
The tax burden on a marginal college skills
investment is low and sometimes negative
• METRs on college
education are modest.
• Low rates at which
breakeven returns are
taxed away –breakeven
earnings increments are
modest, so the increased
tax paid on them is
modest too.
• Negative tax rates usually
due to low or no taxation
of generous grant income.
Data are for a 17-year-old single taxpayer with no children, who undertakes a 4 year course
of non-job-related education, earning 25% of the average wage during schooling. They earn
70% of the average wage in the absence of schooling.
• For some countries, tax
rates are probably even
lower, due to tax subsidies
for student debt (that we
do not account for in
37
this version).
For an average student, the tax burden on
college education is higher, but still modest
• AETRs on college
education are higher than
METRs.
• Labour market returns are
higher than the returns for
a marginal student, so
AETR > METR.
• Very profitable skills
investments face a higher
tax rate than less profitable
skills investments.
Data are for a 17-year-old single taxpayer with no children, who undertakes a 4 year course of
non-job-related education, earning 25% of the average wage during schooling. They earn
70% of the average wage in the absence of schooling. Data for Mexico and the United States
are omitted du to data limitations.
• These tax rates could be
higher than those on
physical capital
investment.
38
Average and Marginal ETRs on College
Education are flat or slowly rising in income
• AETRs and METRs on
college education usually
rise modestly with income
before education.
• Higher taxes on the
returns to education is
offset by higher tax
subsidies for foregone
earnings.
• In most OECD countries
the tax code does not
provide significantly
higher incentives for
higher or lower income
students to attend college.
39
Government recoups most of its costs in most
OECD countries in income tax revenue
• We calculate the ratio of
returns to costs for
governments, based on the
average college premium
earned by a student, and
existing tax and spending
levels.
• For many countries,
income tax revenue alone
covers the costs of
education, often by a
significant margin.
Data are for a 17-year-old single taxpayer with no children, who undertakes a 4 year course of
non-job-related education, earning 25% of the average wage during schooling. They earn
70% of the average wage in the absence of schooling. Data for Mexico and the United States
are omitted du to data limitations.
• This does not include
positive effects on growth,
productivity, employment
etc.
40
Government recoups most of its costs in most
OECD countries in income tax revenue
• For some countries, the
returns to costs ratio is
well above one – the
projected returns to
government far outweigh
the current level of
government costs (direct
spending and lost taxes.
 Increased education
spending could yield
positive returns to the
government.
Data are for a 17-year-old single taxpayer with no children, who undertakes a 4 year course of
non-job-related education, earning 25% of the average wage during schooling. They earn
70% of the average wage in the absence of schooling. Data for Mexico and the United States
are omitted du to data limitations.
 There could also be
skills shortages in the
labour market.
41
Government recoups most of its costs in most
OECD countries in income tax revenue
• For other countries, the
average returns to costs
ratio is below one.
• This does not suggest that
education is not a
worthwhile investment
overall.
• But the fraction of the
returns to education
accruing to government is
below the fraction of the
costs borne by
government.
Data are for a 17-year-old single taxpayer with no children, who undertakes a 4 year course of
non-job-related education, earning 25% of the average wage during schooling. They earn
70% of the average wage in the absence of schooling. Data for Mexico and the United States
are omitted du to data limitations.
42
Older workers face lower financial incentives
to invest in education
• Older workers of all ages
face higher breakeven
earnings increments than
younger workers.
• Older workers have fewer
years to repay the costs of
a skill investment before
retirement, so the peryear investment must be
higher.
• This is very challenging
from a lifelong learning
perspective.
43
The marginal tax burden on in-work training is
also low
• The cross-country
distribution of tax rates is
more compressed for inwork training than for
college education.
• While METRs on college
are reduced through tax
exempt scholarship income,
METRs on in-work training
are reduced more through
tax allowances and credits
of the costs of training.
Data are for a 32-year-old single taxpayer with no children, who undertakes a 3 months
course of job-related education, earning 25% of the average wage during schooling. They
earn 100% of the average wage in the absence of schooling.
44
Subsidies for training quite significant in size
• Nearly half of the costs of
education can be offset
against tax in some cases.
• For some countries,
however, no such
provisions exist at all.
• Taxes reduce costs of
education through
offsetting foregone earnings
and offsetting direct costs.
• In most countries, cheaper,
lengthier forms of training
are subsidised more.
Data are for a 32-year-old single taxpayer with no children, who undertakes a 3 months
course of job-related education, earning 25% of the average wage during schooling. They
earn 100% of the average wage in the absence of schooling.
45
Subsidies for training quite significant in size
• Nearly half of the costs of
education can be offset
against tax in some cases.
• For some countries,
however, no such
provisions exist at all.
• Taxes reduce costs of
education through
offsetting foregone earnings
and offsetting direct costs.
• In most countries, cheaper,
lengthier forms of training
are subsidised more.
Data are for a 32-year-old single taxpayer with no children, who undertakes a 3 months
course of job-related education, earning 25% of the average wage during schooling. They
earn 100% of the average wage in the absence of schooling.
• But for some countries,
more expensive, shorter
periods of training are
subsidised more.
46
Subsidies for training often regressive, and
limited to ‘job-related training’
• Tax allowances/credits for
the direct costs of training
often limited to ‘job-related
training’.
• Ensuring skills spending as
consumption is not
subsidised.
• But more tax support is
thus provided to those who
already have jobs, instead
of those without, or those
who want to change
careers.
• These provisions are also
regressive; more support
provided to those with
larger tax liabilities.
47
For more information, please contact:
Bert BRYS, Ph.D.
Senior Tax Economist
Head Country Tax Policy Team
Head Personal and Property Taxes Unit
Tax Policy and Statistics Division
Centre for Tax Policy and Administration
2, rue André Pascal - 75775 Paris Cedex 16
Tel: +33 1 45 24 15 97 – Fax: +33 1 44 30 63 51
Bert.Brys@oecd.org || www.oecd.org/tax
48