Increasing taxes on profits from investment will reduce investing

It’s a simple enough construction - you get less of whatever you tax. So, if you increase the taxes on profits from investment there will be less investing done:

Britain’s largest North Sea producer has blamed the new windfall tax as it prepares to cut hundreds of jobs and shift attention to outside of the UK.

Harbour Energy says it is reviewing its UK organisation “to align with lower future activity levels” after the tax rate on North Sea drillers was increased from 40pc to 75pc following months of soaring gas and oil prices.

The FTSE 250 company told staff of the planned job cuts on Wednesday. It has not revealed how many jobs will be lost. Industry sources believe it is in the hundreds. It employs around 1,500 in the UK.

The move is likely to ring alarm bells in Whitehall, which has been trying to boost North Sea oil and gas production even as it raids producers’ profits to try and help households facing record energy bills.

One possible reaction here is a shrug and a “Well, that’s how it works”. It’s also possible to mutter that perhaps, as we all insist that Britain invests too little, we should lower the tax rates on the profits from investing.

A much more interesting idea - interesting because it’s obviously wrong - is to insist that people don’t, in fact, consider the taxation of future profits when making investment decisions. Folk are just happy to make any return so those profits can be lifted without affecting the volume of the original investing.

We can even prove that this idea is wrong. A simple consideration of two of the largest financial markets in the world show that it is. US Treasuries pay Federal income tax upon the interest received. US municipal bonds do not pay that Federal income tax. Risk-adjusted - for all observations in this field must be so adjusted - munis pay a lower interest rate than Treasuries. The only possible explanation for this being that people look at the post-tax yield, not the pre-tax one, when making their decision over which to invest in.

It’s possible to go into more detail. Holdings of munis are heavily concentrated among higher rate income tax payers for that’s who the tax-relief is worth most to. Coroporations, who are taxed on interest in an entirely different way, hold near no munis. The only useful, or indeed possible, explanation for these behaviours being that people look at the post-tax income, or profit, from their investments not the pre-tax ones when making their investment decisions.

Anyone saying different has to overcome that evidence from the Treasury and municipal bonds markets in the US. Good luck with that one.

Taxing something reduces the amount of that thing done. So, if we desire more investment, something that large parts of the Establishment are insisting we must have, we should reduce the taxation of profits from having invested.