ChainWhat it assumes · how to break it
Start
The government raises capital gains tax and inheritance tax to help reduce the budget deficit.
1
As a result, more tax is collected on each pound of gains realised when assets are sold and on each pound of wealth passed on at death.
capital gains tax · inheritance tax
capital gains tax · inheritance tax
Assumes: The value of gains and estates taxed stays the same.
But: If asset prices fall, as they can in a downturn, the base shrinks whatever the tax rate.
2
At the same time, asset holders delay selling to avoid realising gains, and plan inheritances through gifts and trusts, so less taxable activity takes place.
tax avoidance · lock-in effect
tax avoidance · lock-in effect
Best link to attack
Assumes: Asset holders can choose when to sell.
Assumes: Asset holders can choose when to sell.
But: Some sales cannot be delayed, for example when a business owner retires or a landlord needs cash, so many gains are still realised.
3
Consequently, revenue rises by less than a simple calculation suggests, and capital gains revenue can even fall for a time if many owners hold back sales.
tax base · Laffer curve
tax base · Laffer curve
Assumes: The behavioural response is large.
But: If the rise is modest, few owners will change their plans, so most of the expected revenue arrives.
4
Therefore, the budget deficit narrows only a little, since these taxes raise a small share of total revenue compared with income tax, National Insurance and VAT.
budget deficit
budget deficit
Assumes: Wealth taxes raise little relative to the deficit.
But: Broader reforms, such as taxing property according to current values, could raise much larger sums because property cannot be moved or hidden.
End
Revenue rises by less than expected and the budget deficit narrows only slightly.
Evaluation chain
- E1However, the revenue gain depends on how far owners can choose when to realise their gains.
- E2Because capital gains tax is charged only when an asset is sold, owners who do not need the cash can hold on until the rate falls or keep the asset until death.
- E3As a result, the higher rate applies to fewer sales, and the lock-in effect also stops assets moving to people who would use them more productively.
- E4So a capital gains tax rise does less for the fiscal balance than expected, while taxes on immobile bases such as land and property are more reliable.
Another way to attack it: An announced rise can lead owners to sell early to beat it, raising revenue in one year and lowering it the next, so short-run figures give a poor guide to the long-run yield.
Can you say this chain from memory?
Members can hide the links, test themselves and track which chains they have mastered.
Practise this chainMembers can hide the links, test themselves and track which chains they have mastered.
Questions this answers
- Assess whether higher taxes on wealth are an effective way to reduce the budget deficit.
- Discuss the advantages and disadvantages of raising capital gains tax.
- Explain why the revenue from a tax rise may be lower than forecast.
Diagram
No standard diagram. A Laffer curve can show the revenue effect of the behavioural response; figures for the share of revenue from wealth taxes make strong evidence.
Reverse and related
Cut in capital gains tax → owners sell more assets and realise gains → revenue falls by less than expected and may even rise briefly.