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.
READER COMMENTS
Garrett
Aug 7 2025 at 2:56pm
Good reminder of how you need to keep your eyes on the state. Feel bad for those who didn’t realize at the lower rate when they could
Rajat
Aug 8 2025 at 12:53am
By ‘rearrange their affairs’, I presume you mean not only that people will hire expensive tax lawyers to find loopholes and workarounds, but that people will curb their working and/or saving?
I agree that such long run effects are the issue. The Grattan Institute here in Australia has claimed that higher taxes on saving will not much reduce saving by high earners because they have a high desire to save irrespective of tax rates. They refer to various studies done in various countries, but I am not sure if they take account of long run responses, not only in shifting income, but actually reducing investment in human capital and effort and hours of work. Here is an example from one of their reports (pp.21-22):
And the papers cited were: Engen and Gale (2000); Benjamin (2003); Ayuso et al. (2007);Chetty et al. (2014).
Scott Sumner
Aug 8 2025 at 11:50am
I always saved more than allowed under my 401k plan, so at the margin that tax incentive had no effect on my savings rate.
A. Squaretail
Aug 8 2025 at 8:33am
Investors slower harvesting of gains isn’t a one time event. Higher gains taxes change investment analysis and require that a new investment have a higher return to compensate for the tax paid when other assets are sold to make the new investment. This often makes holding the old investment more competitive with, or often superior to, the new investment. In short, higher capital gains taxes slow down the flow of capital. Not only doe they reduce the government’s income, they slow investment in new innovations thereby slowing economic growth. This is Economics 101 stuff but seems far beyond the intellectual capabilities of most political or government types.
Scott Sumner
Aug 8 2025 at 11:51am
Very good point. I believe this is called the “lock-in effect”?
Garrett
Aug 8 2025 at 12:15pm
I see this often in my own personal investing. There have been several times where I’ve believed that there was a trading opportunity in my taxable account. However, the value of that opportunity was likely not higher than the drag of realizing gains to take it. Examples like this likely affect overall market efficiency.
robc
Aug 8 2025 at 4:45pm
That doesn’t make sense, unless you think your tax rate will be lower in the future.
And if you are giving up growth to avoid the taxes, it would have to be significantly lower.
Dylan
Aug 10 2025 at 9:07am
If things go well, I will die before realizing any gains which means the tax rates will be zero for my heirs with the step up in basis.
Honestly though, the friction of the taxes I’d have to pay slowing down my trading has probably been a good thing. If there had been zero tax, I probably would have sold my winners when they had merely excellent returns and before they got to life changing.
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