Monday 31 October 2011

Should Capital Gains be Taxed

This was the headline on an article in the Press on Saturday (no on-line version that I can find). The sub- head says that the article reports on both sides of the debate. This is a bit of an obsession of mine (see my earlier posts, here, here, and here), as most of the arguments I have seen on this seem to be making incorrect partial-equilibrium arguments.

So I was keen to see what arguments would be put forward by the expert economists interviewed for this article. In a telling, but perhaps not surprising, commentary on the relevance of our profession for public policy, the number of economists cited in the article on either side of the issue was zero.

There was a quote from an Auckland professor of taxation law and policy to the effect that the absence of a capital gains tax causes "over-investment in property", but as I noted in the second of the posts linked to above, the chain of reasoning needed to get this conclusion is a lot more complicated than one might think, and the combined assumptions needed are somewhat heroic.

I continue to search for a coherent economist rationale for a CGT.


  1. I think you need a political constraint to get an argument for a capital gains tax right.

    I was under the impression that the current tax system effectively taxes some capital gains and not others.

    People who are saying that are for a capital gains tax are doing so just because they want all capital gains to be taxed equally regardless of what the investment was in.

    Although it is more efficient to not tax capital gains at all - it may be politically infeasible to not tax capital gains for some investments. Given this, it may be preferable to tax all asset equally based on their capital gains rather than only tax some.

  2. I'm no economist so I have to attack a CGT on more simple grounds..

    If we introduce a CGT, whatever Govt will simply spend the proceeds! If in 1999 Govt spending was around $30 billion, and today its $70 billion.. why would you want to encourage more spending to often little effect?

    Surely, in a rational but now more frugal world you would look at cutting expenditure before attacking people's savings.


  3. One possibly sensible reason for a CGT is inflation and that we tax nominal returns.

    Say real property (land, buildings) maintains its real value as rents are adjusted for inflation. In that case, the (untaxed) capital gain covers any inflation. Rent (taxable) needs to only cover the required real return.

    On the other hand, interest is fully taxed (both the real and nominal return). If this is true, then real property tax-preferred. A (accrual) CGT would neutralise things (as would indexing the tax system).

  4. @ Matt

    What capital gains were you thinking of that are currently taxed due to a political constraint? In general, it could be right that the distortion between taxing some capital gains and not others is worse than the distortions created by taxing all capital gains, but that case would have to be made empirically based on different rates of substitution between different activities a la Ramsey. I haven't seen anyone try to make that case.

    @ Anonymous

    Taxing the real return on capital is pretty hard to justify on either efficiency or equity grounds; taxing the inflation-adjustment component of nominal returns is an abomination. The inflation tax can be avoided by investing in shares or real assets like property for the reasons you lay out. It is very hard to believe, however, that the distortions created by the inflation tax in inducing people to move from fixed-interest assets to equity are significant compared to the distortions created by the abomination of taxing nominal returns in the first place. That is, even in the face of a constraint that the tax system can't be indexed and inflation can't be reduced to zero, compounding the abomination by taxing the inflation component of capital gains seems to be the worst possible response.

  5. I was under the impression that some capital gains are taxed directly through the income tax system - the enforcement is just sporadic, and the boundary between earned income and capital gain is unclear (namely its broader than just labour income and relatively unspecified in legislation).

    Don't get me wrong - I don't like the idea of a capital gains tax in general. I don't see the point of taxing consumption now and consumption in the future at different rates.

    But I think the issue many people are trying to get at is that its weird that different types of debt/equity implicitly face different tax rates.

    ... that and a bunch of people just really want to tax "rich pricks" at a marginally higher level than everyone else is taxed, and they see this as a way of doing it :P