Where’s the gain in the capital gains tax?

The idea of ‘squeezing the rich’ may be politically attractive. But, says Arthur B. Laffer, it means less tax revenue — as the coalition may be about to learn the hard way

Britain’s new coalition government has a simple mission: to walk the thin line separating huge deficits and political correctness. Just how can a government patched together from former political adversaries raise the revenues needed — and still be fair to the poor, the various minorities and the disenfranchised? The answer they seem to have alighted on is the old saw of ‘tax the rich’. The first salvo in this new class warfare skirmish is to raise the capital gains tax rate, with new upper rates of 40 per cent and even 50 per cent being discussed. And thus the coalition falls for one of the greatest fallacies in economics.

The underlying premise is that the rich, because they own so much of the country’s wealth, can easily afford to pay higher taxes. Also, because they constitute such a small portion of the body politic, their screams won’t be heard. It would be sound logic — if it were true. But it’s not! When these new taxes are fully effective, then the private sector’s counter-offensive will begin. The new Lib-Con government will come to understand what Sir Robert Peel meant when he warned politicians against increasing taxes on the great articles of consumption, because they will be thwarted in their expectations of greater revenue.

People and businesses respond to incentives, and government policies change incentives. It’s really fairly simple. People, especially the rich, can change how much work they do, where they earn money, how they earn money, and when they earn money.

Just compare the UK’s economic growth before and after the tax-reducing Thatcher government.