Interesting piece, but it looks like, correct me if I am wrong, you have re-packaged the idea of “picking winners” as the “Business Angel”. What evidence do you have that the state has the expertise to make these investments and interventions? Wouldn’t it become just another slush fund for promoters and with government contacts? Or ironically, the “innovators” whose major expertise is in writing out government grant applications?

Even if we accepted the “social” justice of CGT, why not make it a simpler redistribution to those on lower incomes. The people can make investments like anyone else, by buying stuff that they think is important or interesting for them.

Let’s tackle the problem from an investor’s perspective. In order to be sucessful in setting up and running a new business there has to be alignment between the interests of the various parties involved. Typically the founder shareholders, senior managment and outside equity investors all do a deal along the lines that they will share the risk of loss and none of them will take much money out of the venture until it is successful, and they will share the proceeds when the business is sold to a larger company or to institutional investors at a profit. In most cases the public in the form of the governement is not a party to this deal, contributing little or nothing and carrying none of the risk.

However when the venture is successful and its time to share the profits the governement shows up and want to take a priorty share in the profit. The bigger the share this non-contributing party wants the less attractive the deal looks to the other investors. In some deals the size of the government take makes one or more of the potential partners say “the remaining return is too low to take the risks involved. Can we do this deal in some other tax location, or should we just do something else with out time and money.”

Not all capital gains are generated by such direct investments. Many are made in a more passive way just by making funding available to the investors who will back new entrepreneurs, or to the larger firms who will buy up the new businesses as they grow, although such passive invstments typically don’t yeild such large gains. However without this funding industry both large and small will not have access to the risk capital necessary for them to trade and without which the economy will die.

In short it is not equitable to tax incomes derived from activities where the particiapnt has born serious and substantial risk of loss on the same basis as income derivedfrom activities where there is little or no risk attached. Otherwise there is a positive disincentive to make the risky investments on which the economy depends.

Finally there is an issue as to the taxation of real gains as opposed to nominal gains. If tax is levied on apparent gains levied as a reult of depreciating the currency (inflation) then there is again a major disincentive to undertake longer term investments. This is very important becuase governemetn has a major role to play in the management of inflation, and they should not be rewarded with larger capital gains tax revenue as a result of failing to control inflation.

None of this is not to argue that there should not be any tax on capital gains. Society needs funds for its common purposes, and to the extent that the gains reflect deferred payment of employment income and interest that would have been taxed had it been paid during the venture then there is a case in equity that it should be taxed when the gain is realised.

So some basic prnciples:

Capital gains tax should be levied on real gains (adjusted for inflation) and not gains generated by the depreciation of the currency.

Capital gains tax should seek to recover the equivlilent tax that would have been raised on employment income deferred and the interest that would have been paid to investors had they made risk free loans to the company.

As far as possible there should be little orr no tax on the excess that represents the return to investors for taking on the additional risks of economic innovation so that there is encouragement for economic growth.

This approach would probably be too complex to apply directly and a simpler if rougher set of rules need to apply. They should however include

Indexation of the cost base to eliminate notional gains generated by the governement lack of control over the depreciation of the currency

Lower rates for people who make gains from long term investments

Lower rates for people who are actively involved in the generation of the economic activity and who take significant personal risk (i.e. a deduction for the value of perosnal guarantees given to banks etc) rather than just passive shareholders

Apart from the lack of indexation the scheme that the UK had until the 2007 budget is much preferrable to the current regime. which taxes active entrepreneurs making long term risky investments on the same basis as people taking short term punts on the property market.

Interesting piece, but it looks like, correct me if I am wrong, you have re-packaged the idea of “picking winners” as the “Business Angel”. What evidence do you have that the state has the expertise to make these investments and interventions?

We do have to pick winners at this point. And the winners have to be green power generation and industry. The science is moving far more quickly than the market on this and we have got to give green investment a kick up arse. If capital gains tax could be used to discourage financial speculation and funds raised directed towards green industry we would see a much safer more stable world.

You make a good point that this may just be used to reward friends and promote businesses which are good at applying for funds over those good at delivering results. However, I don’t think that is an excuse fo inaction. I think the only answer to this is a devolved decision making process. All communities have an incentive to attract investment in these times, and they have an incentive to pick companies which are going to have a chance of long term success.

Nick makes a decent point on business angels. Working in the software industry I see a lot of these kinds of people and, whilst having more money sloshing about would be useful, the main value of a business angel is in the experience they bring to bear. The best ones – the ones that genuine innovators/entrepreneurs want to have invovled in their businesses – are the ones who have the experience and contacts needed to help out the business they’re investing in. Just signing the cheques isn’t enough. The ‘angel’ is only really engaged in the company because they’ve invested their own money in it, something that wouldn’t apply if the government were investing the cash.

Secondly, the government already does provide business funding, albeit by a rather circuitous route (via the EU and RDAs). Despite many promises about fostering innovation, they’re often most interested in giving large (£1m+) grants to established companies rather than giving £10k to 3 people with an idea.

I think that if we want to have a more entrepreneurial/innovative culture, we might actually want to look at the benefits system. Benefits can often be very hard to claim if you’ve had anything other than a conventional employment (not surprising; the infrastructure of the welfare state was built during the era of massive companies employing thousands of people in 9-5 work, with unions playing an active role in politics – it’s not surprising that the rules favour people wokring in those scenarios). Try explaining to the Job Centre that you never became ‘unemployed’, you just stopped getting clients, or your startup business failed. In fact, I’m not at all sure that it would be possible to claim benefits whilst trying to bootstrap a business on a salary of £0. This, at the risk fo sounding like a broken record, is a good reason to back an idea like basic income; for some people it would be the seed funding for their business, enabling those without any money behind them to take the plunge in a way that is currently restricted to those with pre-existing wealth or connections.

Left Outside,

Green energy is one of many areas of economic development that is being funded by private intiatives. Initiatives that are being reconsidered and sometimes cancelled in the light of the 2007 CGT changes.

Government is the very worst group to be given the opportunity to pick potenital winners to be rewarded in this area. Their track record is abysmal. The UK was a world leader in the development of wave power in the 1970′s. Then the nuclear industry leant upon the government to close down funding for further research and for the move from the lab to commercial scale. Now the UK is not a player in this, nor any other leading edge green energy technology.

The only role for government is to set a fair and consistent framework of taxation that raises only enough money to cover only those functions that it is essential for the governement to run, and then get out of the way. Government is not run by highly motivated and omniscient people. With very few exceptions our political class (a group that now includes almost all senior civil servants) are self interested and inexperienced in runing a technology based global business. Ignore their pretensions. They are just not up to that kind of job.

Matt,

I’m very flattered to receive such a response.

I should clarify – I did not intend to argue that CGT should not be raised. My point was only that because there are sensible reasons to worry that higher CGT might lead to lower investment, with negative implications for real wages etc., then anybody advocating higher CGT must be confident these potentially negative effects do not outweigh the positive. Speaking for myself, I just don’t know, but I would be quite prepared to believe that the negative effects are small.

It should also point out that I am not talking about ‘trickle down’ or anything like that. Lets confine the discussion solely to the real wage of everyday workers. While there is some scope to raise real wages of this group via redistribution of various sorts, ultimately by far the largest determinant of the real wage is productivity. If an economy can produce things cheaply, that equates to higher real wages – it’s one of the most fundamental yet overlooked facts of economics. I don’t suppose that lower levels of investment would cause productivity in the UK to fall, but it might cause it to grow at a slower rate. Over time, this would mean the real wages of working people would be lower than it would otherwise be.

Incidentally, I don’t think it’s true that faster growth means larger recessions (further to fall) – growth based upon technological and organisational progress need not make any economy more vulnerable to slumps. Quite the opposites – take a look at the GDP data for some African countries. Recent events have more to do with what generated growth in some countries (“finance”) coupled with the consequences of finance going bust – your data analysis is very interesting, but it is a somewhat small sample and as you say, there are some outliers in there (iceland!) where growth or otherwise might have little to do with the effect of taxes on capital, per se. If your argument is that you are not so concerned to protect investment-led growth, because you think that just leads to larger recessions, I think you are mistaken. Besides, if you are worried about the welfare of the poor, then an economy that grows rapidly with the odd crash can still leave the poor better off than one that grows slowly with gentler crashes.

As far as I know, there is no compelling empirical evidence into the relationship between capital taxation rates and long-run wealth. The determinants of productivity are complex (including culture, institutions, education etc.) and capital investment is only one element. I’d be interested to read any empirical papers anybody might recommend.

You talk about the culture of “get rich quick” – well I don’t like that culture either, but capital taxes are often paid by people who get rich slowly, by working hard and building up a business. Perhaps the capital gain is only realised when a business built up over a lifetime is sold. Some entrepreneurs enjoy overnight success, but if high CGT is worrisome, it is so not because it changes “get rich quick” behavior, but because it discourages steady investment by businesses of all sizes and of all sorts.

I’m not sure how Sir Fred was taxed, but wasn’t most of his money salaries and bonuses? I don’t know how bonuses paid in shares are taxed. I don’t know to what extent the tax system can differentiate between capital gains arising from business investment, and capital gains arising from bankers and private equity types paying themselves in shares.

Incidentally, there is an argument for government subsidy of entrepreneurial activity. One of the things entrepreneurs do is ‘discover’ – what things cost to make, what the market for them is and so forth. These discoveries benefit other businesses, who can learn from the experience of the entrepreneur – but the entrepreneur doesn’t care about the benefits to others, so entrepreneurial discovery is under supplied by the private sector. This argument is put forward by Dani Rodrik. Such a system would have to avoid trying to pick winners.

I would have a lot more faith in your statistics if you’d inclued more than 7 countries. I’m sure, by carefully choosing which seven countries, I could show a correlation between anything and anything else (I am not accusing you of doing this). You should have included all OECD countries.

This all adds to a very important debate and there is some real food for thought in the feedback here. Overall, what I’m trying to suggest is that the ‘old way’ of doing things needs to be questioned down to its most base root.

It’s been a generally accepted norm that a low(ish)-tax economy is the key to success. I would personally argue that this approach has been one of the key contributors towards our current economic situation. Most evidence that I’ve seen suggests the size of the boom dictates the depth and duration of the bust and this goes back some way in history.

What is the ideal? Is it to, dare I say the Brownian phrase, ‘abolish boom and bust’ and seek slow and steady growth? If this were possible, what effect would this have on employment levels and social justice? Can a democratic system permit this? What role should the state play?

I personally think the allignment of CGT to income tax rates (RobertD, I agree with the need for some form of indexation relief), along with less laissez-faire regulation, would certainly allow for more slow and steady growth. I also believe that a degree of state intervention can help this.

The main thing I believe, above all else, is that there has never been a better time for us to seek a new, fairer approach and we have to scrutinise everything…

Cabalamat, I just saw your post. It was rather difficult finding CGT rates as there doesn’t seem to be a single source. I did have an entire piece on my sources, assumptions etc. but it was far too long to publish. This did include an explanatiion of why I selected the countries I did and I’ve pasted it below.

It would have been a lifetime’s work to discover all the OECD nations’ CGT rates!

The nations were selected purely through subjective means. The UK, USA, Germany and Japan were chosen simply as they are common countries for comparison. Sweden was chosen as I suspected it would have a very high tax rate – I was wrong – and is often cited as the beacon nation when illustrating how Social Democracy could work. Iceland and the Republic of Ireland were chosen due to their expediential growth and subsequent collapse over the last decade. Other than the UK, I didn’t know a single CGT rate when selecting these economies.

The Economist had an interesting piece on this a few years ago.

‘The Nordic region [...] has the world’s highest taxes and most generous welfare benefits. And yet Sweden, Finland and Denmark (Norway’s oil sets it apart) have delivered strong growth and low unemployment, and rank among the world’s most competitive economies. Nordic companies are strong in technology and research and development. Their health-care and educational systems are much admired. And, unlike other European countries, most Nordic states run healthy budget and current-account surpluses. Sweden, whose 9m people make it by some way the biggest Nordic country, is a particular favourite. A year ago the Guardian, a British newspaper, said it was the most successful society the world had ever known.

The truth is that there is never a single economic model for other countries, even the Nordic states, to follow. Neither membership of the EU nor adoption of the euro seems necessary: Sweden is in the EU but not the euro, Finland is in both, Norway is in neither. Different countries have different strengths. Mr Bildt puts forward his own tongue-in-cheek recipe for the perfect “Nordic model”, stretching the geography: Finland’s education, Estonia’s progressive tax policy, Denmark’s labour market, Iceland’s entrepreneurship, Sweden’s management of big companies and Norway’s oil. The right conclusion, in other words, is that it is wisest not to look for a single-country model at all, but just to take best practice wherever you find it.’