The IFS capital gains tax proposals are…..strange
The IFS has some proposals for the reform of CGT. Things like exit taxes, equalising rates with income tax, forcing both CGT and death tax to be paid on the same assets. But it’s more complex than that. Much more complex than that.
These reforms would mean that CGT would sometimes be payable on top of inheritance tax (and, under the second option, at the same time). That is not a flaw. CGT and inheritance tax are serving different purposes – inheritance tax is not a substitute for CGT. On death, if an asset has accrued gains, it is appropriate to tax these just as much as if the asset were sold the day before death, when it would currently be taxed.
As we’ve noted before an 85% tax at death sounds more than a little de trop. 40% IHT and 45% top rate CGT on the same pot of money? Not passing that basic fairness test we think.
Then there’s this:
CGT rates vary across assets. They are lower than tax rates on earned income and, in most cases, income from capital. These rate differentials are unfair and create a range of undesirable distortions.
Thus we get that standard progressive call that CGT and income tax rates should be aligned, be equal even. For why should those who labour for a living be paying a higher tax rate than those who speculate for it? ‘S’unfair, innit?
Well, yes, except these are the rates currently paid:
The CGT rates on shares are very different from those on non-share assets. Because - as they say - shares are already reduced in value by the corporation tax charged upon the profits of companies. Given this CGT on shares is already well aligned with income tax rates. In fact, for basic rate payers well above.
What this means is that if nominal CGT rates are equated with income tax rates then the CGT charge will be well above income tax rates. Which really isn’t the point at all. So, to equalise actual rates it will still be necessary to have a different, significantly lower, rate for CGT on shares. Equalising rates means different tax rates that is.
Exit taxes are, we think, just vile, so ‘nuff said there.
But where it gets really complex. Quite rightly the proposals take account of the Mirrlees point. That we don’t, in fact, want to tax normal returns to capital at all. Therefore something akin to inflation indexation but set at the risk free return rate. Mirrlees himself suggested the gilts yield which we think too low - the FTSE one sounds better to us. But that’s a detail. It becomes only economic profits which are taxed, not regular returns to capital.
Which in one sense is good yes. We can’t see it being remotely politically possible of course - the shouting when it becomes obvious that rentiers get to live tax free would see to that we think. Yes, it’s - in one sense - wholly economically sensible but we can’t see it being allowed to stand, nor being implemented.
This thought then runs into another problem: Schumpeterian Profits. As that Nordhaus paper points out these are the profits that accrue from entrepreneurial activity - they are not the returns to financial capital from it. Of those Schumpeterian profits near all flows to us, the consumers, in the form of the consumer surplus. Only some 3% sticks to the hands of the entrepreneurs themselves.
Yet note what this proposed tax system does - it taxes those entrepreneurial profits at the highest rates our tax system has. Top income tax rates, or CGT at that same top rate, or if left to the kiddies at 85%.
We end up not taxing at all the coupon clipping bourgeois while dunning the entrepreneurs - those who both make us consumers rich and who also drive the entire system of market capitalism forward - at the very highest rates of the entire system. There’s an error in the reasoning that got us here if we end up with a proposal so gobsmackingly awful.
It is true that we want to tax economic rents. But economic rents and entrepreneurial returns are different things and that’s the distinction that isn’t being made. The solution to economic rents is to go out and destroy the things that allow economic rents to be collected - then we can, righteously, have a lovely low tax rate upon the entrepreneurial returns. Say, zero as a nice starting point for negotiation?
Tim Worstall