Business Tools Blog

The politics of taxation and dealing with a financial crisis is crazy in the US, but nothing like what they are dealing with in the UK.  In the US, our top income tax bracket is 35% (steep to be sure), but not even close to the UK’s top income tax of 50%.

If you’ve been following the UK news, you’ll see the age old battle over whether or not they should raise capital gains tax. In a Taxation briefing, Chartered Accountants report, “Given the discrepancy between the current  Capital Gains Tax (CGT) rate of 18% and the top Income Tax rate of 50% it is no surprise that an increase for non-business or investment assets is proposed. The new rates will be “similar or the same as those applied to income”, which could be as high as 50%.”

General secretary Brendan Barber said: “The vast majority of taxpayers never come into contact with capital gains tax as they are simply not wealthy enough to buy and sell the assets that bring capital gains. But most will find it incomprehensible that they pay more tax on the wages they earn from putting in a full day’s work than the wealthy do from sitting back and watching their assets increase in value.”

I think most people would agree with Barber, but having a majority opinion doesn’t make it right. Professor Paul D. Evans of Ohio State University, completed a study, The Relationship Between Realized Capital Gains and Their Marginal Rate of Taxation, 1976-2004. He found that there was an inverse relationship between the Capital Gains Tax Rate and the amount of Taxable Revenue Received.  The Adams Smith Institute reports, The Effect of Capital Gains Tax Rises on Revenue:

Evans found that taxpayers continue to exhibit significant sensitivity to the tax rate on capital gains in deciding how much of their gains to realize over time and would report fewer gains if the rate were raised. He found that at current US tax rates, a 1 percentage point reduction in the marginal tax rates on capital gains might trigger a 10.32 percent increase in realized capital gains. Behavior in recent years is broadly similar to that found in earlier studies.

He reviewed the many studies that seek to estimate the revenue-maximising rate, i.e. the answer to the question “What tax rate on capital gains would raise the most capital gains revenue for the government?” (The revenue maximizing rate is not of course the optimal tax rate for the economy). He found that based on 2004 data the revenue maximizing tax rate is just under 10% – 9.69% to be precise. He found that raising the US capital gains tax rate from the current 15% would reduce federal capital gains tax revenue and that additional revenue would be lost from other parts of the income tax and from other federal taxes due to reduced investment, employment, and income. He found that the optimal capital gains tax rate to maximize public welfare, and to help the federal budget, is closer to if not zero.

Hopefully the coalition Government will look to the US experience, and not try to reinvent the wheel.  In this case ignoring history could be a very costly mistake.