The Progressive Tax System and Returns on Educational Investment: The Armenian Case

Abstract

Over the years many researchers have time and again proven that higher taxes, although promoting equality to some extent, hamper economic growth. As to why this happens, there are many theories ranging from incentives to work to human capital depreciation. Human capital has been put in the center of endogenous growth theories in the last decade. The returns on education were also largely discussed as a way to calculate the efficiency of the educational system in providing workers with higher value added. However, the effects of the tax system in use are usually omitted. In this article we will discuss the effects of a progressive tax system on higher education. Precisely, on the decision making processes of individuals that are choosing their career path and the specialization. In the first part we define the notion of human capital and explain the reasoning behind the choice of the private educational investment IRR as the target of study. We then provide the mathematical definition of the returns to education that we will be using to evaluate the said tax effects. Next we briefly review the international literature on the effects of taxation on economic growth. We then modify the optimization equations to reflect the effects of the tax system on the educational IRR. Finally, we discuss the Armenian case and calculate the before and after tax IRRs for the progressive and flat rate tax systems. We conclude with the follow-up study propositions that arise from the current lack of data in the Armenian job and higher education markets.