Capital Gains Tax and the Laffer Curve

The Lib Dem conference this year was a big disappointment. Instead of proposing that we all ride round on bicycles powered by moonbeams or women-only shortlists for offshore windmills, it was all rather realistic and sensible.

The only really stupid idea was Clegg's suggestion that the rate of capital gains tax be increased in order to be able to reduce the tax burden on the lower paid. People get all heated about CGT, but it is a very minor source of revenue, it covers less than 1% of total government spending, a point which everybody, from Clegg to Booth missed.

Philip Booth in City AM yesterday:

Indeed, when the top rate was increased to 28 per cent under pressure from the Lib Dems, it was felt by the Treasury that this was the rate that maximised the revenue from the tax.

As it happens, CGT revenue has roughly halved since the rate was increased, although this may have been for other reasons. Nevertheless, it is quite possible that we are already on the wrong side of the Laffer curve – in other words, beyond the revenue-maximising rate (a notion popularised by the economist Arthur Laffer via his famous curve) – as far as CGT is concerned. Certainly, we are not far away from the top of the Laffer curve.

From this morning's City AM Reader's Letters:

The biggest yield from capital gains tax (some £7.4 bn) came under Alistair Darling's giveaway when liability could be crystallised at just 10 per cent for those who had held assets for a while.

People talk a lot of rot about the Laffer Curve, the lefties deny it exists and the right wingers often claim that every cut in rates leads to an increase in revenue.

The sensibles merely point out that if rates are too high, you can increase revenues by reducing the rate. This is the mathematically correct view, but ignores the fact that the revenue-maximising point still depresses the size or efficiency of the economy.

As it happens, I know from personal experience that ten per cent is the rate which clients were happy to pay, they weren't fussed about claiming deferment or hold over reliefs, or simply not triggering the gain or anything. They just sold what they wanted to sell and sent one-tenth of the gain to HMRC. A while ago I read that the Americans had noticed the same. So in all probability ten per cent is the revenue maximising rate.

It's still a bad tax of course. The irony is that the real point of CGT is not to raise revenue by taxing capital gains (hence and why the largest source of capital gains, owner-occupied housing, is exempt), the real point is to prevent people turning taxable income into otherwise tax free gains. So the system is quite different in different countries, and changes regularly in the UK, they are always struggling to reconcile these two quite different aims, but there you go.