Does anyone here have an interest in economics? I’m writing a post for my blog on that capital gains tax is unrelated to economic growth but is actually mostly a wealth tax that kills the goose that lays the golden eggs, even from a state’s perspective. I’m writing in Swedish but the argument is basically this:
Consider an isolated island with an unchanging money supply of gold coins. Because the money supply is fixed, growth will lead to falling asset prices. One year there are ten huts and ten canoes with a total value of a hundred gold coins. A decade later there are ten brick houses and twenty canoes whose total value is still one hundred gold coins.
If all the islanders got richer at the same pace then the number of coins that anyone’s assets was worth never increased and the island chief got no capital gains tax at all, even though there was high economic growth. (Only if someone grew richer faster than the others the price of that person’s assets increased, but only as much as others’ decreased.)
Now let’s introduce inflation. Due to a change in ocean currents a steady stream of wreckage laden with gold begins to wash up on the shores. The price of everyones’ assets rises a lot and suddenly the chief gets capital gains tax from everyone, even if there was no economic growth at all because everyone was busy searching the beach for coins.
This means that a capital gains tax is actually not a tax on production or wealth increase but rather a tax on wealth that consumes capital at a rate determined by inflation. A 30% capital gains tax and a common 7.5% annual increase of the money supply translates into a 7.5% * 30% = 2.25% annual wealth tax.
Have you looked at the model of taxing non-work income in the Netherlands? Until 2017 they had a very simple system:
You had an amount of assets, whether 1000 Euros in a savings account or 5 million Euros worth of shares.
The tax people assume that you make 4% on your assets
You pay 30% of that 4%
So basically you can see it as a flat wealth tax of 1.2%, or a flat CGT rate of 30%.
Recently this was nuanced a bit with different tax rates depending on how much you have, but it’s still a very simple system. It seems to work OK and it’s quite hard to game, unlike many other systems where you can move things around between asset classes. Of course, it encourages people to invest in shares rather than leaving them in a bank account getting 1%, at which point you lose money.
Before this system, the Netherlands had no CGT. It was common, when you bought a house age say 30, to get a 30-year interest-only mortgage and instead of paying off the principal, you bought shares every month which grew tax-free at an average of 6-7% over the 30 years. During the entire time you had a large principal debt, but because mortgage interest was (and still is) fully tax-deductible, your share investments were in effect subsidised by people who rented their home, and the gains were totally tax-free.
(The above is just for background, in case you didn’t know about it. In terms of your actual argument, I would ask to what extent any real economy resembles your though-experiment island. It’s a very basic principle of economics that if you tax activity X it has a negative impact on people’s desire to do X, but governments need to get money from somewhere and if you don’t have CGT you need to tax something else. I don’t find CGT objectionable in principle; it tends to be paid by better-off people.)
Right, a 1% wealth tax is certainly less destructive than a 90% income tax, for example. And yes, a CGT lower than the average real rate of return is more like an income tax than a wealth tax. However, with the interest rate and and money supply growth situation of today CGT’s are a de facto wealth tax of a few percent.
That means that a percentage of the productive capital is consumed by governments each year and won’t be there to produce goods the next year. The production capacity of the whole economy shrinks which is counterproductive even from a government profit maximizing point of view as it means less future tax income.
That means that a percentage of the productive capital is consumed by governments
each year and won’t be there to produce goods the next year.
But how different is this from a higher income tax rate, which will remove people’s ability to save?
Interestingly, when France had a general wealth tax (Macron replaced it with a tax only on real estate wealth), there were very few deductible assets, but one of them was if you invested in individual (or, via FCP/SICAV structures, multiple) start-up companies below a certain size. (Like most such measures undertaken in France, these companies had to be French at first, but of course the EU made them change that to any EU-based company!) So perhaps this acknowledges your point.
France also has a CGT-efficient structure called a Share Savings Plan, where your money is invested in French^h^h^h^h^h^h EU companies of any size and after 4 years you can get it back with no CGT to pay on the profits. However, you do get to pay ~15% social security contributions on those same profits; those are very hard to avoid in France on any income other than pensions.
One other interesting recent development in France is that CGT is now taxed at your marginal rate for income tax in the current year (whereas before it was a flat 29% or something). This seems reasonable and progressive to me.
In both cases there will be less future productive capital but in the case of income tax, there is a floor at zero. In times when the economy grows slowly or shrinks (and right now it’s quite possibly shrinking) income tax will prevent investments and growth but it won’t eat from the existing capital. A wealth tax higher than the growth rate will relentlessly chip away capital, more and more reducing society’s ability to produce goods.
A wealth tax higher than the growth rate will relentlessly chip away capital,
more and more reducing society’s ability to produce goods.
Possibly, but most CGTs aren’t wealth taxes. By definition a CGT is at a lower rate than the growth rate. And the Dutch-style wealth-based tax is designed to encourage people to invest.
Also, your argument seems to assume that a substantial proportion of the wealth-generating capital is in the hands of (a) individuals who are (b) local tax residents, and hence subject to these taxes. I wonder what that proportion is?
How so if it is inflation and not growth that determines how much CGT is charged?
Good point! I don’t know. One one hand ownership has an incentive to move where taxes are lower. On the other hand, apart from governments and foundations most things are ultimately owned by individuals and most of them are not willing to leave their country to lower their CGT.
Is this a real problem, though, except when inflation is out of control?
As a counterpoint, in many countries, currency gains are not subject to CGT. I currently hold (a) a fund with a notional 10% loss in its denominated currency where I’ve actually made a (non-taxable) 20% gain in Euros because I bought it at the right time, and (b) a fund in the opposite situation.
I suspect that for tax systems to try to take into account anything other than nominal local currency is politically difficult and practically near impossible.
Inflation has been showing a lot more in assets such as stocks and real estate than in CPI. The growth of M3 money supply in most currencies is around 7% a year which is what’s causing such assets to increase about the same percentage in price. With real growth negative a 2% de facto wealth tax could be a serious problem.
