Punitive wealth taxes are unnecessary and ineffective

John Macdonald

May 6, 2021

Say it softly: the Treasury might finally have realised that punitive wealth taxes are as unnecessary as they are ineffective.

In the March budget, Chancellor Rishi Sunak set out a strategy of spending and borrowing to cover the pandemic costs. There has been speculation that burdened with the glorious purpose of rejuvenating the Treasury’s coffers, he would go on to announce a punitive rise in Capital Gains Tax (CGT) come Autumn. News that a watering down or even a reprieve on such a rise is welcome, for many reasons.

Hikes to CGT are generally a very poor way to raise revenues. Unlike income tax, CGT is voluntary, paid only when an asset subject to it is sold. Where the Laffer effect on income is well known, it is perhaps even more prevalent with capital gains; the more punitive it is to sell, the less will be sold.

Evidence from across the world shows that revenue from CGT rises when the rate is lowered, not vice-versa. We should be cautiously optimistic that the Chancellor recognises that now is the time to nurture greater economic activity, rather than curtailing recovery with the weight of an added tax burden.

This is especially true as the lockdown continues to unwind and consumer confidence returns to pre pandemic levels. With household savings having risen in the pandemic, £16.2bn saved in the last month alone, there is a huge war chest to fund a boom in consumer spending.

If the Treasury wants to raise revenue in this environment, broadening the VAT base by eliminating exemptions and lowering the rate by 5 per cent could raise £64bn. If wealthy households are going to spend more as shops reopen, it makes little sense in the current context for them to get £40 off a £200 Armani baby-grow.

The Chancellor has also suggested that he believes March’s measures to be sufficient in returning public finances to a stable footing. If he is correct, the Treasury should begin to consider restructuring the tax system to boost the slow growth that has plagued the economy since the financial crisis. This would mean distinguishing between an increase in the stock of debt, to pay for the pandemic, and a structural deficit, like the permanent unsustainable spending that needed to be tackled after 2010.

Going for immediate revenue neutrality and boosting the rate of growth will “pay” off for the state coffers in the long run. With a forecast of 7.25 per cent growth this year, the Chancellor would do well to use the figure as a baseline commitment to an equal or higher annual growth rate.

It’s also worth noting that even if the Chancellor does decide to raise CGT, he has committed to not doing so until 2026. At this point, he must either renege, or any such raise would take place after a General Election and would be a part of a very different set of political priorities.

If the Conservatives are, as they say, committed to a dynamic free market economy, they should focus on reducing the tax burden, boosting growth, and making it as easy as possible to build a business. If they can maintain the momentum building as we open back up, there will be no need for a discussion about raising CGT come 2026.

Author

Written by John Macdonald

John Macdonald is Head of Government Affairs at the Adam Smith Institute.

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