Why the IPPR’s tax idea won’t raise more revenue

The IPPR says we should tax income from wealth the same as income from working. Except, obviously, Sir John Mirrlees had things to say about this. Which they acknowledge and good for them. It’s actually a rather fine piece of working out of what a tax system should be.

It has one great flaw in it. The assumption that doing it properly will raise more revenue. Properly being to do it as Mirrlees said of course. There should be a rate of return allowance. It’s only economic rents that should be taxed, not normal returns to capital.

Great, then they model the 10 year Treasury yield at 2.6%. Which, in this era of QE, it is. But as it hasn’t been outside QE. At more normal long term rates of perhaps 5% – outside excessively inflationary periods that is – the Worstall Calculator (here, simply a guess) says that such capital gains taxation would reduce revenue.

Oh, and the Mirlees rubric applies to income as well as capital gains. And we’d have to get rid of the double taxation of dividends as well. And lower the top rate of income tax.

But, you know, it’s a great report because it does get the basic economics of the discussion right. It’s just the sums it gets wrong.

7 comments on “Why the IPPR’s tax idea won’t raise more revenue

  1. As far as I can see all this report wants to do is put NICs on all unearned income, and whack CGT up to income tax rates. Nothing to do with changing the way capital is taxed, just higher rates all round. They mention the Mirlees RRA very briefly, but thats it. Its hardly the centrepiece of the report. Thats just big tax rises.

  2. “There are a range of other smaller CGT reliefs, such as the Enterprise Investment Scheme, which we also proposing scrapping but which our modelling does not include. These schemes complicate the tax system, reducing the tax base and creating opportunities for avoidance with often limited economic justification.”

    I do quite a bit of work on EIS. It’s not complicated and I know quite a few businesses that would have failed without the funding.

  3. These schemes complicate the tax system, reducing the tax base and creating opportunities for avoidance with often limited economic justification.

    Wouldn’t higher taxes also “reduce the tax base”, i.e. deter people from economic activity, or are these people also denialists like the Fat One?

  4. Hi Tim, author of the report here. Thanks for taking the time to comment on our report and thanks for your supportive comments.

    I just wanted to pick up on your point about the figures we use, as it’s not correct. You say that the figure we use for 10-year Treasury yields is too low, as we only use the yield as it stands today. However, what we actually use is a weighted average of yields for the period 1980-2016 (https://uk.investing.com/rates-bonds/uk-10-year-bond-yield-historical-data).

    During this period, yields averaged 16.8%. However we use a weighted average based on the value of taxable gains in each period for assets disposed of in 2015/16. This gives a weighted average yield of 4.7% – very similar to your 5%. We then use this to estimate that these changes would raise £90bn over five years with no RRA, and £20bn with one.

    The 2.6% figure that you quote wasn’t the overall yield we used in our calculation, just the weighted average yield for assets held for between six and seven years specifically.

    Apologies if this wasn’t made clear enough in the report. Hope this helps to explain why we think these changes with an RRA would still raise a substantial amount of revenue.

  5. Shreya,

    Very good to see you joining the discussion.

    “It is known” that CGT has a very big impact on individual decisions – people will postpone crystallising gains etc to avoid incurring CGT. I’ve seen estimates that the revenue collected peaks at a very very low rate – perhaps as little as 12-15% – and very definitely at MUCH lower rates than the peak of the income tax curve.

    How do you model these sorts of effects?

  6. @ Shreya Nanda
    Thank you for the clarification.
    But that still ain’t good enough. When I was young Actuaries used 3% as the risk-free interest rate required to justify/incentivise deferment of gratification and the norm for the equity risk premium is a further 3% (it can vary from -2% at the peak of the dot.com bubble to +8% during wars/bad slumps). So you ought to use 6% REAL not 4.7% nominal, which is less than half the real (inflation-adjusted) expected rate of return required to justify investment. If you plan to increase the tax rate on gains without providing a tax refund on losses then the required rate of return will be higher still.
    There are a goodly number of academic papers on the Equity Risk Premium (Professor Lo at MIT is pretty good) and some less-academic articles (such as mine).
    I should be in favour of taxing REAL Capital Gains equally with income: however – even as a Pensioner with a defined benefit pension – I consider the first priority on achieving taxation fairness is abolishing the NIC levy on earned incomes introduced by Gordon Brown as a pretence that it was not an increase in income tax and replacing it with a uniform increase in income tax that covers pensions and investment income.

  7. Ignoring capital gains for a start, isn’t the easiest way to tax all income (from investment or labour) the same is to simply use imputation ? So for example any dividends paid are credited gross as a mix of cash and tax credits depending on the rate at which the company (or organization) has paid tax on those earnings. The recipient then pays any additional tax (if there is any) based on their personal marginal rate. This also largely decouples company tax from investment decisions for the owners and removes a lot of the incentive to indulge in artificial income structuring to avoid taxation – you pay it one way or another – but on one scale.

    Does need rules around overseas ownership, transfer pricing etc but those exist and can be managed.

    Then deal with capital gains in a different mechanism if you must – certainly by treating how such matters are classified for a start to avoid people converting income to capital gains too easily. Just as an example have tax rules that specify that any activity carried on with the intent to resell cannot accumulate capital gains and have certain qualifying holding times.

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