Why do we tax capital less than labour?

The Covid-19 pandemic has undressed the horrific inequalities that have come to define the many worlds of British society and exacerbated them in the process.  

The Office of National Statistics concluded that in the Financial Year Ending of 2020, the income of the richest 20% was over six times higher than the poorest 20%. These are figures that haven’t yet assessed the impact of Covid-19 on British society but the mass redundancies hitting those on lower and middle-income salaries should serve as an indicator as to how they are faring.

While billionaires’ wealth rose to a record high of $10.2tn the Trussell Trust revealed that since the pandemic around 11m people have used food banks, with over 4m being children. These are figures that should shame any government but many in the ruling Conservative party, however, have always regarded poverty as the consequence of individual deficiency. The uproar about the possibility of extending Free School Meals was a testament to that. Various Conservative MPs regarded it as bad because poor families would spend it on drugs and brothels

Suggestions on remedying inequality have long since been explored. A pay rise for some of the most desperate in the NHS feels overdue and far more materially rewarding for their bravery than national ovations in evenings. As frequently highlighted,an increase to the minimum wage would reduce people’s dependence on welfare and save the treasury money by dipping less into tax credits, which is ultimately subsidising employers. Raising top-rate taxes would further create funds to target left-behind areas and focus on housing, schools and hospitals.

But the country is missing a goldmine of tax revenue and seriously misunderstanding wealth inequality by taxing work-based income over earnings derived from capital. Much of a wealthy individual’s earnings doesn’t actually come from work salary but other sources such as shares and property. This income is taxed at a far lower rate than incomes of work at the top of the earnings scale, and it is here where inequality is allowed to stealthily soar. 

The Institute for Public Policy Research (IPPR) stated last year that the government could accrue an extra £90bn across five years if it taxed earnings from capital the same way it taxed work. The study also reveals the favourable treatment of capital gains relative to work. For example, a full-time employee earning the living wage would pay a tax rate of 2% from additional £20,000 earnings from dividends, whereas additional £20,000 earnings from work would be taxed at 14%. They also found that those in higher income tax bands stealthily avoid tax in the current system by relocating their income origin from wages into capital gains and dividends. 

While this might sound like a left-wing idea, it was actually one of the flagship policies implemented by Ronald Reagan in 1986, and in the UK by the Tory chancellor Nigel Lawson in 1988. These were both reversed by subsequent administration with the Labour government under Blair dropping capital gains tax to a historic low in 1998. 

The tables have now turned – the proposal to equalise the rates was included in the 2019 Labour manifesto but absent in the Conservative policy promises, although the idea has been discussed recently by the Chancellor as one way of raising funds after the pandemic. 

One way to address some of the weaknesses of capital gains tax has been proposed by Economists at the University of Berkeley, including Gabriel Zucman (a major proponent of a US wealth tax). The “capital gains withholding” proposes those who have a wealth over $50 million would pay tax on their capital gains now, before any sale has been made, this stops tax money being deferred or avoided altogether via inheritance. Their paper states the super wealthy hold $18 trillion in unrealized capital gains and this method of taxation could raise $2 trillion in a 10yr period if enacted in Biden’s first budget even without raising capital gains tax rates.

Capital gains withholding was designed to raise a large sum post pandemic to finance an economic rebuild required but also negates some of the issues that arose from raising capital gains tax. 

New ideas on tax capital are being proposed because taxing work has always invited the argument of the government taking from the hard labour of individuals, especially from the right. While I personally think this is an unfair characterisation, if one agrees with this sentiment, it’s hard to justify that money earned from work should be valued less than that of income derived from owning capital.

After all, compensation from one’s work is always a result of their own effort, whereas dividends can be earned from shares inherited from one’s parents, as a result of a lucky investment or as monopolistic rent-seeking. This is not to say that risk taking or entrepreneurship should not be rewarded – just simply that it should not be rewarded any more than work.

Equalising the taxation of capital and labour would reconfigure the tax system to be less about taxing the hard work of the average citizen. There is a natural inclination in the UK to shy away from bold economic promises these days but in the aftermath of the wreckage left by austerity and the pandemic, the country is being pulled apart by its inequality. Inequality doesn’t just affect individuals; it shifts a community’s perception of itself and how it is regarded, or disregarded, by the ruling class.

A consistent failure of previous Labour leaderships has been to argue for tax positivity and the sense of pooling wealth together to fund universally beneficial services. This is partly because everyone thinks Labour is coming after their wealth rather than those with the broadest shoulders, an idea that would not be prevalent if Labour proposed a rise on capital gains.

Britain is moving towards a period of uncertainty after the pandemic eventually disperses. The country has been irrevocably altered by what has besieged it for the majority of 2020. It’s also likely, with a Tory government at the helm, it will be pulling apart in different directions. Those with the most are far likelier to emerge from the pandemic relatively unscathed compared to those at the bottom. For the country to prosper, that yawning wealth gap must finally be corrected.

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