IPPR joins the call fro capital gains to be taxed as income

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IPPR has issued a report this morning calling for the alignment of tax rates on capital gains tax with the equivalent income tax rate applicable to the taxpayer making the gain. In effect, they are arguing that gains should be taxed as income. This is a policy proposal I entirely agree with, as I noted recently. It is virtually inexplicable that when we are worried about increasing income and wealth inequality in the UK, which organisations as left-wing as the IMF argue is harmful to society, the tax system is designed to exacerbate this trend. I say virtually because for some this is entirely explicable: that increase in inequality is their aim.

The Guardian report on the IPPR proposals is supportive.

The FT's is much less so. The attack comes from that friend of all right-wing economic causes, the Institute for Fiscal Studies. Behind its claimed veil of impartiality the IFS continues to be anything but. And come to that, it's not too hot when it comes to tax issues either. It has criticised the proposal. As the FT notes IPPR has said:

We estimate this could raise up to £120bn over five years, falling to £90bn when accounting for potential behavioural effects.

In response, they note:

Stuart Adam, a senior research economist at the Institute for Fiscal Studies, another think-tank, expressed doubts about the accuracy of the forecasted additional revenues for the government.

“I would not give the headline numbers much credence as deriving a figure is very difficult to do,” he said. “Would I believe these numbers of £90 billion and £120 billion? No.”

In fairness, I should note they also said:

However, Mr Adam admitted that the capital gains tax proposals had merit and under certain conditions implementing the suggestions could improve the current tax framework.

But I want to go back to the main IFS comment. It's important for three reasons. I frame these within the six reasons f0r tax that I noted in my book The Joy of Tax, which:

1) To ratify the value of the currency: this means that by demanding payment of tax in the currency it has created a government gives that currency value within its jurisdiction as it has to be used for trade;

2) To reclaim the credit-created money the government has spent into the economy in fulfilment of its democratic mandate;

3) To redistribute income and wealth;

4) To reprice goods and services;

5) To raise democratic representation - people who pay tax vote;

6) To reorganise the economy i.e. fiscal policy.

First, the Institute for Fiscal Studies clearly thinks that tax is all about raising money. It is not.

Second, if tax revenue cannot be raised then it seems that the IFS largely dismiss the idea.

Third, they appear to give insufficient emphasis to the importance of tax systems as a whole.

The first two are significant: it is a deeply economically orthodox view of tax to think that it is simply a tool for raising revenue that must be maximised in a microeconomic sense as if a government is the same as any other entity subject to the rules of the market, which that microeconomic approach would suggest to be the case. This view, best summarised of late in the IFS's own Mirrlees Review, is profoundly wrong. It fails to recognise the importance of tax as an instrument of social and economic policy in its own right. I would suggest that the IFS is repeating its own error in endorsing the Mirrlees view in making these comments on the IPPR proposal.

My third point is, however, the most significant. When capital gains tax was introduced in 1965 its purpose was not, as such, to raise revenue. Instead it was a defensive tax, introduced to support income tax by preventing the recategorisation of income as gains, which would, therefore, fall out of the scope of tax altogether at that time. The criteria for measuring the success of capital gains tax is, then, whether or not it succeeds in this objective of supporting income tax. Quite clearly it cannot do so if the rate of capital gains tax is much lower than that for income tax: when that is the case the incentive to re-categorise income as gains remains, and as such the whole purpose of the tax is negated.

This issue is the focus of my work with Prof Andrew Baker of Sheffield University on tax spillovers. This was the subject of an academic paper earlier this year, and other papers will follow shortly. What we argue is that the criteria for assessing the effectiveness of any part of the tax system is to determine whether or not it causes harm to another part of the same tax system, or to the tax system of another jurisdiction. Very clearly if capital gains tax is charged at rates lower than income tax it does cause harm to the income tax system. In that case a tax spillover arises: there is a loss of revenue, a loss of effectiveness within the tax system and an incentive to avoid, at the very least. All are destructive, most especially when the overall aim of the tax system is to be progressive, which is undermined by this objective, and that tax system also has the social policy objective of reducing inequality, which this rate differential exacerbates instead of reducing.

In that case the IFS objection on the grounds of whether or not this policy might raise significant revenue is irrelevant. The whole purpose of equalising tax rates would be to change behaviour. The object would be to remove the incentive to re-categorise income as gains and to as a result minimise the tax avoidance activity that takes place around this rate differential to the benefit of society at large. It really is time that the Institute for Fiscal Studies understood these most basic issues with regard to text design, which their blinkered adherence to orthodox neoclassical economics prevents them doing.

I applaud IPPR's approach. This change needs to happen.