Laffer Curve in the United Kingdom?

The FT presents a compelling narrative surrounding the UK government’s struggle to enhance capital gains tax (CGT) revenue, which appears to have backfired spectacularly:

The UK government’s ambitious plan to ramp up capital gains tax revenue has hit a significant snag, with receipts tumbling by 18 percent, dropping to £12.1 billion for the fiscal year 2023-24. This decline comes on the heels of a sharp reduction in the annual tax-free allowance, slashed from £12,300 to £6,000, according to data released by HM Revenue & Customs (HMRC) on Thursday.

In a separate report earlier this week, HMRC’s provisional figures, calculated using a different methodology, hinted at an additional 10 percent drop in CGT receipts for 2024-25. . . .

The previous Conservative government’s drastic cuts to allowances in 2023-24 unexpectedly expanded the pool of taxpayers subject to CGT, adding 87,000 new potential contributors and bringing the total to 378,000. The allowance is set to drop even further to £3,000 in 2024-25.

Additionally, Chancellor Reeves raised CGT rates in her October Budget, now ranging from 18 to 32 percent, compared to the previous brackets of 10 to 28 percent.

Proponents of this tax hike may argue that the decline in revenue is merely a temporary phenomenon, reflecting investors’ choices to delay realizing capital gains. They assert that eventually, the elevated tax rates could yield greater returns than their lower predecessors:

Several tax experts anticipate a brief uptick in tax revenue for 2024-25, covering the period prior to last October’s Budget—Labour’s first since regaining office—before witnessing a decline thereafter.

Hollands commented, “Given the rampant speculation leading up to that Budget, including whispers of even steeper hikes and possible alignment with income tax rates, we certainly observed clients crystallizing gains ahead of the event.”

While this perspective is plausible, it raises some thought-provoking implications. Advocates for higher capital gains taxes seem to be implying that, “The disappointing revenue figures reflect how individuals respond to incentives when deciding the timing of asset sales.” This is indeed true; however, it’s essential to remember that individuals often react far more strongly to these incentives over the long term rather than the medium term. Consequently, the increased tax rates in the UK may inadvertently drive income towards more tax-friendly jurisdictions like Ireland.

More broadly, the persistent malaise in the European economy can be partially attributed to the long-term ramifications of various tax and spending policies that have gradually eroded the tax base. Countries such as Switzerland, which have opted out of a large government model, are faring better than their higher-tax European counterparts.

When it comes to raising capital gains taxes, I observe three primary effects:

1. Short-term revenue decreases due to the timing of asset sales.
2. A slight increase in medium-term revenue, as assets are eventually sold.
3. A disappointing long-term revenue outlook, as individuals and businesses reorganize their affairs to minimize tax liabilities.