The phrase “Laffer Curve” might not pop up at dinner parties, but it’s quietly influential in decisions like Rachel Reeves’ recent Capital Gains Tax (CGT) adjustment. Reeves’ choice to set CGT at 24% (and 18% for basic rate) has raised eyebrows, with some saying it’s a classic example of the Laffer Curve in action. But what does that really mean? And is this move about revenue optimisation, or does it reflect political calculations as well?

What’s the Laffer Curve?

The Laffer Curve is an economic theory attributed to Dr. Arthur Laffer, but it has deep historical roots. Laffer himself admits he only popularised the concept; it’s an idea that dates back centuries, with thinkers like 14th-century philosopher Ibn Khaldun and even John Maynard Keynes referencing similar principles. The idea is fairly straightforward but has profound implications for tax policy.

In essence, the Laffer Curve suggests there’s a “sweet spot” for tax rates, where the government can collect the maximum revenue without pushing taxpayers to change their behaviour in a way that decreases tax income. If taxes are too low, they won’t generate enough revenue. But if they’re too high, people may reduce their spending, investment, or work effort – or even find ways to avoid tax altogether. This effect means the government ends up collecting less than it could if it had chosen a more moderate rate.

The sweet spot, according to Laffer’s theory, is that “just right” tax rate where people pay willingly without feeling compelled to change their economic behaviour.

So Why 24%?

In her recent budget, Chancellor Rachel Reeves set the CGT rate at 24% for higher rate tax payers (and 18% for basic rate), a rate that surprised some observers. Although it was lower than some expected – rumours had swirled about an increase as steep as 39% – it still represents a significant rise. So, why did Reeves stop at 24%?

There’s a recent precedent here. Back in April 2024, Jeremy Hunt reduced the CGT rate on second homes from 28% to 24%, aiming to encourage second-home owners to sell. This adjustment served two goals: bringing in tax revenue while also freeing up homes for first-time buyers, helping ease the chronic shortage in housing stock. Treasury officials reportedly advised Hunt that 24% was an “optimal rate” according to the Laffer Curve, ensuring enough revenue without discouraging people from selling.

Reeves seems to have taken a similar approach, possibly influenced by similar Treasury advice. The rationale is that 24% sits in that Laffer Curve sweet spot, where the government can maximise CGT revenue without prompting investors to avoid or defer their capital gains.

Not Too Radical: Peston’s Take

Renowned commentator Robert Peston offered a perspective on X (formerly Twitter), suggesting that the 24% rate isn’t as bold a reform as some had hoped. According to Peston, HMRC simply doesn’t have the resources for a root-and-branch overhaul of CGT, so Reeves opted for a less disruptive option. But there’s likely more to it.

Going too far with CGT could backfire, as it risks pushing investors to hold onto assets rather than sell and pay higher taxes. Reeves would have been well aware that a significant hike could lead to an actual drop in tax revenues – exactly what the Laffer Curve warns against. By keeping the CGT rate at 24%, she appears to be aiming to balance the need for revenue with a rate that won’t discourage investment.

A Nod to Economic Reality

This restrained CGT adjustment shows an awareness of the limitations of tax policy. Politicians, regardless of party, are finding that there’s only so far tax rates can be pushed. Tax policy that’s too aggressive can lead to what’s known as “behavioural leakage” – where taxpayers find ways to reduce their liabilities, from delaying sales to shifting investments abroad. Reeves’ 24% rate reflects an understanding that, while raising taxes sounds like an easy way to bring in more cash, it’s not always that simple.

In the broader context of her budget, Reeves’ move also highlights Labour’s focus on pragmatic fiscal policies. Instead of squeezing every drop from CGT payers, the 24% rate keeps CGT revenue stable while limiting the potential side effects on the investment market.

So, is Reeves having a Laffer? Quite possibly. The 24% CGT rate may not have excited those calling for a bolder approach, but it reflects the reality that tax policy is about balance. Whether this rate will prove optimal or not, the intent is clear: maximise revenue while keeping investment incentives intact.