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The Adam Smith Institute Blog

Britain's capital gains tax: Would rate hike lead to less revenue?

A previous rate hike in the capital gains tax led to a decline in revenue collected.

By Tim WorstallGuest blogger / June 20, 2010

A woman walks past London's Stock Exchange in London's City financial district in May. A proposal suggests that Britain raise its capital gains tax to raise more revenue. Sometimes, though, revenue falls when taxes go up.

Lefteris Pitarakis/AP/File

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But please, don't try to invent your own facts. The TUC has a paper out on how we really ought to raise Capital Gains Tax. You know, stick it to those rich people. A paper in which they say the following:

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There was an unambiguous rise in the effective tax rate with regard to Capital Gains Tax when the tax rate rose from 20% in 1987/88 to be set at income tax rates throughout the rest of this period. In other words, the tax rate increase resulted in extra revenues. The so called “Laffer” effect, where it is claimed that increased tax rates result in reduced revenues did not happen.

The first problem here is the logical misunderstanding of what the Laffer Curve is trying to point out. Sure, a rise in the nominal tax rate is going to raise the effective tax rate. Raise income tax from 10% to 90% and the effective tax rate on incomes will rise.

*Shrug*.

What we actually want to know, and what the Laffer Curve is indeed all about, is does a rise in the effective tax rate lead to a rise in revenue collected?

So, why don't we have a look at what revenue was collected when the effective tax rate rose? That information is here.*

Well, when the CGT rate rose, the amount collected, the actual revenue from the tax, fell. In fact, when we account for inflation (those HMRC numbers are nominal, not inflation adjusted) the revenue from CGT did not rise to its 1989 level until 2006/7 (they just peeked over the earlier level at the very peak of the internet and stock market boom in 1999, to be entirely accurate). By which time of course CGT rates had been lowered again.

So, contrary to the claims of the TUC the revenue collected from Capital Gains Tax in the UK does indeed seem to show Laffer curve effects. A raise in the rate led to a fall in revenue collected and a fall in the rate led to a rise. It's still entirely open for people to argue that this is correlation, not causation, of course: but the claim that a rise in the rate led to increased revenues is simply flat out wrong.

In the spirit of comity and amity which we here at the ASI are famous for (and myself being both a paragon and exemplar of that, of course), might I suggest to the TUC that they find someone new to write their tax papers? I have a feeling that I know who wrote this one but to spare blushes won't point any fingers. I would very strongly suggest though that the employment of someone who has a grasp of both economics and data would be a good idea: however vague that grasp might be, some connection with reality is to be hoped for.

* My thanks to fellow Fellow at the ASI, Richard Teather, for pointing me to this table.

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