Mike Simkovic has a new paper up on ssrn, "Distortionary Taxation of Human Capital Acquisition Costs." Cribbing now from the abstract:
High pre-tax rates of return to post-secondary education suggest underinvestment in higher education. Traditional explanations in the labor economics literature seem insufficient to explain the magnitude and persistence of these unusually high returns. This article proposes a novel explanation: distortionary taxation.
Economic theory suggests that inconsistent tax treatment of investments that are substitutes for one another distorts investment decisions and drives down investments in the disfavored investment relative to the favored investment. Differences in the tax treatment of higher education relative to other forms of investment could create an undersupply of educated labor relative to physical or financial capital. Such distortions would reduce economic growth and social welfare.
Part I of this article reviews empirical evidence linking higher education to increased earnings and economic growth, considers dual consumption and investment motives, and reviews the literature on student responsiveness to financial incentives; Part II reviews the empirical evidence on whether the level of investment in higher education is at, below, or above the optimal level and finds unusually high rates of return consistent with underinvestment; Part III presents a formal mathematical model illustrating the link between tax rates and rates of return; Part IV reviews optimal tax theory and the distortion problem; Part V contrasts taxation of favored investments with taxation of higher education; Part VI considers policy options to offset tax distortions.