The War on Saving

by Andrew Stuttaford
There are many reasons why the U.S. private-savings rate is so disastrously low, not least among them the income stagnation suffered by large swaths of the population over the last few decades. There is also, however, the fact that taxes are disproportionately heaped on income, while consumption escapes comparatively lightly. Matters are made worse still by the way that savers are punished by the tax systen, a pain that will increase as the provisions designed to pay for Obamacare kick in and, potentially, we see means-testing of Social Security and Medicare.
 
Adding even further to savers’ misery is the failure of the tax system to acknowledge the impact of inflation on capital gains and investment income. Inflation can reduce real gains/income to zero or less, but the tax man takes no account of this when taking his (all too real) cut.
 
Mrs. Thatcher, a friend of the thrifty (that’s why she correctly opposed means testing of U.K. retirement benefits) always understood this. She slashed income tax rates, hiked VAT (that makes her some sort of socialist, I am sometimes told), and she indexed capital gains for inflation. Her successors were rather more short-sighted.
 
Writing on the London Spectator’s blog, Peter Young takes up the story:

“Fairness” is said to be an attribute of the coalition’s fiscal policy. But it is difficult to see how this can be seen as anything other than extremely unfair. The main CGT rate was raised from 18 per cent to 28 per cent in last June’s budget without taxpayers being allowed to deduct the inflationary element of gains.

Calculating the amount of the tax take accounted for by inflationary gains is relatively simple. In the past, inflation was accounted for by an “indexation allowance”. The last year of the full indexation allowance for CGT was 1997/8.  In that year, CGT receipts were £1.45 billion, and the Treasury estimated the ‘cost’ of the indexation allowance at £1.7 billion. So, without indexation allowance, CGT should have raised £3.15 billion. That implies that 54 percent of otherwise taxable gains were purely inflation.
 
The 2010 Budget estimate is that CGT receipts next year (2011-12) will be £3.3 billion. Applying the same 54 percent suggests that £1.8 billion of that is tax on purely inflationary gains. The different inflation profiles of the 1983-98 and 1996-2011 periods suggest that the inflation element of today’s gains would be slightly less than it was in 1998, but not by much: the 1998 figure of 54 per cent reduces to 49 per cent for 2011, which means that £1.6 billion of CGT receipts for 2011/12 will come from taxing purely inflationary gains.

So, the worse the performance in controlling inflation, the more revenue the Government raises from CGT. Inflation is already causing enough difficulties for citizens, especially the old who live on fixed incomes drawn from the sale of long-term investments — and who are by no means ‘rich’. To tax the results of this runaway inflation simply adds insult to injury.

Indeed it does. And it does so here too. It’s (way) past time to stop taxing purely nominal “gains.”