22 May 2010
The increase in Capital Gains Tax proposed by the coalition government will not bring in the estimated extra revenue to the Treasury, according to a new paper from the Adam Smith Institute (ASI). Instead it will diminish funds coming in and widen the deficit rather than narrowing it.
The ASI's research looks at the experience of other countries, notably the United States and Australia, and shows that increases in the rates of capital gains taxes there have led to reductions in revenue. Conversely, it has been decreases in the tax that have led to rises in revenue.
The effect will be even sharper in the UK, claim the Institute. Unlike income tax, capital gains tax can be voluntary - people can decide when to cash in their gains and may postpone this. As the proposed increases are widely seen as temporary and are likely to be lowered later, many people will leave their assets to await a more benign tax rate. The normal annual flow will diminish, leading to a sharp drop in revenues, and reinforcing the experience of other countries.
The Institute also disputes the suggestion that when capital gains tax levels are below those of income tax, people will switch from one to the other to escape taxation. It quotes figures from several countries, which suggests that this does not happen in practice.
The government should not impose an across-the-board increase in Capital Gains Tax, but should instead distinguish between short-term speculative gains and long-term asset appreciation. Without that distinction, the proposed tax increase will do serious harm to the economy. Madsen Pirie, president of the Adam Smith Institute, says:
"In intending to tax the rich, politicians, without understanding the effects of their actions, are proposing measures which will decrease the Treasury's tax take and make the deficit even worse This is hardly qualifies as sensible economic policy."