Coalition capital gains policy will reduce revenue by £2.48 billion

19 June 2010

According to the Adam Smith Institute this reduction in revenue is equivalent to over 30,000 public sector job losses.

In a new report the Adam Smith Institute calculates that tax revenues will fall by £2.48 billion if coalition tax policy of bringing capital gains tax rates in line with income tax rates becomes law. It points out that if the deficit is not to be widened further this reduction in revenue will be equal to 30,000 additional public sector job losses or equivalent cuts in the capital budget.

The report uses new evidence from Ireland, Sweden and Switzerland combined with existing analysis from America, Australia and Britain to identify more precisely the revenue consequences of CGT increases in the UK. It looks at both revenue losses from capital gains tax and from other taxes as a consequence of the economic damage caused by CGT rises.

Amongst the new evidence considered is the result of CGT rate changes in Ireland and Sweden. The 1997 Budget in Ireland halved the rate of capital gains tax from 40% to 20%. The then Minister for Finance, Charlie McCreevy, was heavily criticized on the grounds that this would reduce revenues. In fact revenues rose considerably, almost trebling and greatly exceeding official predictions.

The report draws together international evidence of CGT rises to show that for every 1% point increase in the CGT rates revenue will fall by 2%. This could involve a revenue loss of £880m.

The report also highlights the extent to which revenues from other taxes would be lower as a consequence of the negative effect on economic activity caused by CGT rises. Evidence from Switzerland shows that cantons which eliminated CGT had 3.1% higher growth over those that did not. Since a tax on capital reduces the amount of capital that can be formed and profitably used, the consequent lower levels of output, employment, and consumption would reduce a wide range of tax revenues. The report estimates that the effect on other tax revenues would be £1.6bn per annum.

Lastly the report addresses the fallacy that CGT rises are necessary to prevent ‘switching’ of income to lower taxed capital gains. Since only about 5% of gains come from assets held in the short-term and possibly affected by such switching, the revenue effects are negligible. Moreover, many countries with no capital gains tax such as Belgium and Hong Kong succeed in dealing with this issue.

In total the reductions in revenue that will result from the implementation of coalition capital gains policy will amount to £2.48 billion.

To put the consequences in perspective this will involve finding substantial additional cuts in public spending akin to over £30,000 public sector jobs or equivalent cuts in the capital budget.

Dr. Eamonn Butler, Director of the Adam Smith Institute, said:

“Media analysis suggests this policy has arisen as a result of a political arrangement rather than careful economic analysis. When we have a dangerously large deficit politicians must take especial care that fiscal policy measures are adopted on economic rather than political grounds. Otherwise the deficit will worsen as a result of lower growth and reduced revenues, the opposite of what is intended.”

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