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Madsen Pirie: Why the Coalition should rethink its plan to raise capital gains tax

Madsen Pirie Dr Madsen Pirie is the President of the Adam Smith Institute, a leading free market think-tank.

The coalition has meant compromises; all coalitions do.  Some things that should have happened will not, and some things will happen that should not.  In the rough and tumble of politics things can be modified and smoothed at the edges, and made acceptable.  Most of the coalition programme looks good.  In addition to the much-needed reforms, it might once again arouse the self-confidence in Britain that we are a society which can solve its problems.

Now for the bad news. The proposal to raise capital gains tax to the level of income tax must be changed.  To raise it from 18% to 40% (or even 50%) will be a hammer blow against saving and investment.  The political cry that "the rich must pay their fair share" has been used to justify a tax hike that will hit quite small savers, the more so if the threshold is dropped to £2,500 as trailed in the Lib Dem manifesto. 

Savers have been hard hit. Gordon Brown raided their pension funds, turning the best pension fund in Europe into a nightmare of black holes.  Then he praised spending for its job-sustaining power, ignoring the fact that it is saving that provides the investment to enable tomorrow's jobs.  And now interest rates have sunk below inflation, guaranteeing that anyone who saves is actually losing money by doing so.

To top all this with a huge rise in capital taxes is folly.  It will hit people who have invested in buy-to-let homes for their pension. It will hit many people whose 'gains' have resulted from inflation, rather than any real rise in value. It will drive people to save outside Britain, moving capital offshore.

The Treasury justification is that we need to combat 'leakage,' or people taking their reward in capital instead of income, seeking out the lowest tax rate.  Yet examination of other countries - which the ASI did in its new report, The Effect of Capital Gains Tax Rises on Revenues - shows no evidence that this happens in practice.

That same report also shows that when capital gains taxes are increased, revenues fall, and that when they are lowered, revenues rise.  There is a Laffer Curve in spades for capital taxes because they are voluntary. People can choose whether or not to realise capital gains, and they tend not to do so when capital taxes are increased.  People will look at the huge rise and conclude that rates must come down later, and will prefer to wait until they do before they realise their gains.

This is a tax which will do much harm, do none of the things claimed for it, and not raise the revenues forecast for it.  It makes no economic sense at all. 

Please, Mr Cameron, please, Mr Clegg, drop this proposal.  At the very least, modify it so that it only applies to short-term gains realised with a year (as is done in the US).  Thereafter let the low rate stand, or better still taper it to zero after a few years.  You have both made compromises, gentlemen, now please make another one.


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