Just for the heck of it, I did a yahoo search of "Taking the time to". I came up, believe it or not, with 5,300,000,000 hits.  For "by taking", I had much less--just over two billion. That should tell us something. The chances that the student in question had already heard a "by taking time to..." construction are fairly good.
   Take the time to and taking the time to are in a sense fixed constructions, but they do have syntactic content, and they are also open-ended. So they are in that in-between lexico-grammatical world that construction grammar or cognitive grammar addresses with some facility. In this lens, grammar is suddenly far more fluid and dynamic than it would be if we only looked at a handful of sentence types and a fixed set of formal rules.
   It's also interesting to think about what cognitive content is assumed or expressed by the notion that time can be "taken", or that taking the time can be a purposeful way to accomplish something else, like "showing that you care." These are highly purposeful, highly meaningful constructs, and learning a language involves, at least in major part, picking up these kinds of structures. The assumption is that grammar is a meaningful part of it, not just a set of forms that the words get cast into.
   I see no reason to suspect that the student can't follow a shorter version, such as "By taking the time to study, you have improved your chances on the test." By smoking, you ruin your health." ("*By smoking ruin your health" might work with a comma after ruin.)  In which case, a short conversation might reveal that the construct is already there, but, as Bruce says, just a routine slip. Beyond that, with no student to talk to, this is conjecture, and a flexible range of approaches might be best.
  What does it mean that time can be "taken"? Or that it can be spent or lost or wasted or saved?  That is another question that would be routine in cognitive linguistics, as it has been for Lakoff and Johnson (among other texts, Metaphors We Live By.)
   I have a hard time characterizing "taking the time to show that you really care" as a noun phrase, as Bob has suggested. (Maybe I misread.)
   Am I wrong in saying prescriptive grammar won't allow a "by phrase" as subject?  I said that once about prepositional phrases, and Martha Kolln was kind enough to correct me. ("Over the fence is out of bounds." I keep hearing these now on the golf course.) I still think that might be an easier prescriptive approach than saying a noun phrase can't be both object of preposition and subject, particularly when the construct in question doesn't look at all like a noun phrase. In a course devoted wholly to grammar, all that will come up, but it might just be too much to lay on a developing writer.
   I'm very happy that this debate has provoked such rich and interesting responses. I'm once again happy to part of the list.

Craig
   
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