High Taxes, Welfare State Can Waste ‘Investments’ in Human Capital

NOTE: A similar version of this article appeared in the Charlotte Observer.

• Human capital is a key component in a society’s ability to lift living standards
• But proper incentives must be in place to encourage people to acquire and utilize human capital
• “Investments” in human capital will be wasted if politicians get these incentives wrong

 

The North Carolina Senate’s recently-proposed $1 billion tax cut plan was met with howls of protest from the Left, most of whom decried the potential “cuts” to state government programs.

According to the left-wing NC Policy Watch, such tax cuts will cause “underfunding of needed public services in communities across the state,” including school classrooms, early learning programs and job retraining programs.

Their protest of the proposed tax cuts is centered in no small part on concern that lower tax rates will not generate sufficient revenue for North Carolina to develop its human capital to help drive future economic growth.

But what if it actually were the case that it is higher taxes and liberal welfare state policies advocated by the left that erode human capital?

From an economic standpoint, there is little disagreement regarding the importance of human capital in promoting gains in wealth.  The level of human capital in society plays a decisive role in its level of prosperity.

But even massive investments in human capital will fail to create the desired results if society promotes the wrong incentive structure for people to utilize that vital resource.

As noted economist Thomas Sowell wrote “Maximum utilization and dissemination of existing human capital is achieved by incentives that reward those who have it. This induces existing possessors of human capital to use it more extensively for the rewards and – more important in the long run – encourages others to acquire more human capital in order to reap similar rewards.”

When human capital is unleashed, society’s ability to produce a greater abundance of wealth grows, lifting the general standard of living. But for people to expend their time and energy in acquiring and utilizing human capital, there needs to be an expectation that benefits will outweigh the sacrifice.

“Redistributional policies, on the other hand, reduce incentives to use human capital, and especially to engage in the difficult task of acquiring it,” Sowell continues.

Sadly, far too many politicians fail to observe this last point. Instead, they narrowly focus on ramping up “investments” in government-run education, oblivious to the fact that the welfare state policies they also promote work to stifle any potential gains we may reap from the increased human capital. Spending billions of taxpayer dollars on education and job-training programs becomes a relatively pointless exercise.

We’ll set aside for the sake of this article the debate over whether government-run or voluntary institutions are preferable for acquiring human capital, which takes all sorts of forms, including schooling, job training, or self-directed skill acquisition.

Why go to the effort of acquiring human capital and figuring how to best utilize it to improve your standard of living, when the government is going to take between a third to a half of the rewards of your effort? Why sacrifice so much time and energy when it requires no human capital to collect government welfare benefits?

In short, people respond predictably to incentives. When the successful acquisition and utilization of human capital is punished, there will be less of it. Conversely, when people are rewarded without having to acquire and utilize human capital, more people will choose that path. Reducing the rewards for those successfully utilizing their human capital, while rewarding those not utilizing any, will result in less human capital being acquired and put to use. Our economy’s output suffers, our standard of living falls.

Moreover, while we may still see kids attending school, many are more likely to just go through the motions knowing there is marginally little benefit to acquiring meaningful human capital. Just look at the extremely high rates of high school graduates in North Carolina needing remedial classes when entering community college.

Recent tax cuts – along with the Senate’s latest tax cut proposal – show that at least some legislators recognize these realities, and acted to increase the rewards for those most effectively acquiring and utilizing their human capital.

The discussion on making “investments” in human capital to improve our economy only looks at half the picture. Many of the resources devoted to making human capital more widely available will be for naught if politicians fail to also look at the incentive structures facing those making decisions about acquiring and utilizing their human capital.