Saturday, 9 May 2009

Capital gains tax - part legitimate - part theft

I'm in the middle of reading George Cooper's "The Origin of Financial Crises". After looking at the section called "A brief aside - on the topic of inflation and taxation" I realized something that had never occurred to me before, about capital gains tax. I already knew that when the government print (or otherwise allow the creation of) new money, then this is a kind of tax. If the total money supply went up 10% then in the long term the spending power of our savings would diminish by 10% and the government would have an extra load of money in its coffers. But I had also assumed that if, instead of having our savings in cash we had it held in some asset like gold for example then our "savings" would be protected from the government... but I was wrong! And here's why:

Imagine a world in which, for decades, most countries had a near zero inflation rate (hard to imagine I know!). Now lets say you'd been tipped off that your government was about to double its money supply overnight. In preparation for this you use all your savings to buy gold. The government then create the new money and as expected the value of your national currency halves relative to other currencies of the world. The value of your gold, as measured in any foreign currency, remains unchanged - but measured in your own currency appears to have doubled. Now here comes the nasty surprise - when you then try to sell your gold back in to your own currency, your government step in and say "please pay us capital gains tax!". That's not fair. Your capital has not gained any value at all! Its the same stuff! Its value, as measured in any other currency, has not changed! Why should you have to pay a "gains" tax when there has been no gain!

Now you may be wondering why I've given this entry the title of "part legitimate - part theft" and that's because I can see a legitimate reason for capital gains tax. If, during a low inflationary period, a rich person invests in some stock that genuinely rises in value (as measured in any currency) then I think it is reasonable to tax the gain. After all, why should we allow rich people to gain extra money simply by virtue of being rich. So in conclusion I'd say that taxing any genuine component of a gain is legitimate, but taxing "imaginary" gains, caused by the government printing money, is simply theft.

I wonder if this observation could be grounds for withholding part of your capital gains tax?
  • Perhaps you could legitimately only report your estimated "true" capital gains after having allowed for any government-induced inflation?
  • If a tax is called a "gains" tax, are the inland revenue allowed to tax you when there are no gains? If a tax was called a "bicycle trading profits tax" and you made some money by trading cheese, would the inland revenue be allowed to use the bicycle tax to take money from your cheese trading profits? Would any lawyers out there care to comment?
P.S. I was just explaining the contents of this blog entry to someone else who didn't quite get it and I had to try explaining the story from another angle. So here it is. Imagine you've saved £10,000 which will buy you a new car, call it the Toyota ZPF-X, when your current old banger finally conks out. Of course you've already paid income tax on this money. Now you stored this money in some kind of stock/bond/gold/whatever. Now fast forward a few years and your old banger finally dies. The government have been printing loads of money and so now inflation has caused the same Toyota ZPF-X to cost £15,000. Your investment has protected you against your currencies inflation, and it is now worth £15,000. Your savings have stood still - you started with enough money to buy the car and you've ended up with enough money to buy that same car... you've already paid the income tax on that money. But now the government want to tax you for a second time on your "gain".

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