Investing in People: The Case for Human Capital Tax Credits

It is now widely recognised that human capital accumulation and research and development (R&D) are key drivers of economic growth, as is documented in most standard textbooks (e.g. Acemoglu, 2007; Romer, 1996). Estimates from the US suggest that increasing levels of human capital over the second half of the last century accounted for approximately one third of productivity growth (Griliches, 1997), while some estimates of the social rate of return to R&D in the manufacturing sector have exceeded one hundred percent (Jones and Williams, 1998). Despite the contribution of both human capital and R&D to economic growth, the UK fiscal system does not treat the two equally when it comes to employer incentives to invest. Specifically, firms that invest in R&D are able to claim generous tax relief on their investments whereas there is no such across-the-board incentive to invest in the training of their workers. This is despite the fact that the rationale for government support to firm investment in human capital is similar to that for R&D and both are important for economic growth. Moreover, this unequal treatment of physical and human capital stands in contrast to practice in many other countries.