There is a general perception in the debate around the tax treatment of capital income that individuals who earn capital income pay much lower tax rates than wage and salary earners. Sometimes this is true. However, there are circumstances where the capital income of some households may be taxed at much higher rates than labour income – particularly for pensioners relying on interest income or young families saving for a home deposit where the value of their savings is largely eroded by inflation. 

This note explains the complexity of capital taxation using examples from a new online tax calculator. It shows three illustrative situations in which capital income can be either under- or over-taxed relative to labour income:

• a high-return fixer-upper: an individual who renovates a property and realises a large capital gain on sale
• young couple relying on interest: a couple saving for their first home deposit in a bank account – where the majority of their interest income simply offsets the negative effect of inflation on their savings
• property investor in an inflation surge: a case where high inflation causes nominal returns to overstate real gains.

An online capital income calculator tool allows you to investigate how these different scenarios play out. It illustrates that while some forms of capital income are taxed more lightly than labour income (e.g. high-return capital gains), others are taxed more heavily in real terms (e.g. bank interest income).