I have found a UK company that sells a low cost 16 bit Absolute optical encoder.They do require a allignment tool but I don't know their price.
Farnell sells them for 116.86GBP plus VAT ea. but in quanities of 15 they are $51.34

http://www.avagotech.com/assets/downloadDocument.do?id=4284
http://www.avagotech.com/products/product-detail.jsp?navId=H0,C1,C5231,C4935,C4975,C5449,C5423,P89643

If 3 people were to buy together that would be 5ea, just what is needed ea for a Microscribe (http://www.immersion.com/digitizer/) style digitizer and that would be only $256 per person.

that is still expensive, why not use a lower cpr incremental encoder on a timing belt, your digitaliser arm has no load on it, so the inertias not a problem, accuracy may even be better.

Absolute is nice, but you can always just reset the encoders from a home position.

For really cheap incremental encoders look at agilents AEDR 8000 series reflective chip type, not exactly robust but if your already doing a pcb you could mount one on it.

farnell has 100pc for £7.95 allegedly

It isn't that expensive compaired to a Microscribe at $3800.

A 16bit encoder is very nessary when your using 5 encoders.
read through the "Digitizing arm options" post they have allready determined this.(Page 17 see MaxLogan's post 5th one down)

Resetting the home position requires more hardware an software routines to handle it.

tbh i hadnt read the post mentioned, but i would like to point out that although incremental encoders require resetting, that is not particularly difficult, and you only have to reset every time the power is cycled, could just embed a 9v battery in it to keep the encoders counting :)

now you mention 65k ppr, well lets see, 1:16 timing belt + 1024 ppr incremental rotary encoder ( with x4 decoder) gives the same resolution, minus whatever accuracy losses you see in the timing belt, which i suggest would be minimal. That makes the tradeoff one of cost vs ease of assembly and marginally simpler electronics.

Personally i dont have the budget to build one of these, i was merely pointing out a potentially cheaper way of doing the encoding.