Laffer Curve in the United Kingdom?

The FT has an interesting story on the British government’s attempt to boost capital gains tax revenue:

The UK’s efforts to increase revenues from capital gains tax have backfired, with receipts plummeting in the wake of big cuts in allowances.

The government’s CGT take fell 18 per cent from the previous year to £12.1bn in the 2023-24 fiscal year, even as the annual tax-free allowance was halved from £12,300 to £6,000, according to data released by HM Revenue & Customs on Thursday.

Separate provisional figures — calculated using a different methodology and published earlier in the week by HMRC — indicated a further 10 per cent drop in CGT receipts in 2024-25. . . .

The slashing of allowances by the previous Conservative government in 2023-24 made an additional 87,000 taxpayers potentially liable for CGT, taking the total number exposed to the tax to 378,000.

The tax-free allowance was halved again to £3,000 a year in 2024-25.

Reeves also increased CGT rates in her Budget last October to between 18 and 32 per cent — up from the previous rates of between 10 and 28 per cent.

Defenders of the tax increase might point to the fact that the revenue drop merely represents a decision by investors to delay the realization of capital gains.  In the long run, the higher tax rates may yield more revenue than the previous lower rates:

Several tax experts said they expected tax revenues to rise briefly in 2024-25 — which covers the period before last October’s Budget, Labour’s first since returning to office — and then decline.

Hollands said: “Given the rife speculation that preceded that Budget of even steeper rises and even a potential alignment with income tax rates, we certainly saw evidence of clients crystallising gains ahead of the event.”

That outcome is certainly possible, but it’s worth thinking about the implications of this argument.  Supporters of higher capital gains taxes are implicitly saying something to the effect that, “The revenue intake was disappointing because people respond to incentives when deciding when to sell assets.”  Yes, but unfortunately for the UK Treasury, people respond far more powerfully to incentives (in all sorts of ways) in the very long run than in the medium term.  Thus higher tax rates in the UK may lead to more income gradually being shifted to lower taxed areas such as Ireland.

More broadly, I believe that the current malaise in the European economy partly reflects the long run effects of various tax and spending policies, which have slowly eroded the tax base.  European countries that did not opt for a big government model, such as Switzerland, are doing better than their more highly taxed neighbors. 

When countries increase their capital gains taxes, I see three effects:

Lower revenue in the short run, due to the timing of asset sales.
Somewhat higher revenue in the medium term, as assets are eventually sold.
Disappointing revenue in the very long run, as individuals and business rearrange their affairs in such a way as to reduce their tax liability.

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