Whoever wins the next general election will face extremely difficult choices on taxes and spending.
As the independent Institute for Fiscal Studies pointedboth Work and the Conservatives ruled out changes to the four big revenue generators, income tax, national insuranceVAT and corporation tax.
And while both parties have made relatively modest spending commitments, there seems little doubt that revenue from other sources will be needed, given current spending plans already drawn up from 2025 – which have been described by the Institute for Government as “implausibly tight.”
How could a new government raise funds?
Assuming that both parties remain faithful to the existing tax rules and opting not to take out loans – although this is certainly a possibility – it is therefore worth considering what revenue-enhancing measures might be envisaged.
The Labor Party has already confirmed that it plans a series of revenue-raising measures – namely increases North Sea oil and gas taxes producers and the application of VAT on school fees – but these are very small in the overall context of total government expenditure.
This has led to intense speculation about what other levers Raquel Reeves could pull if she, as expected, became Chancellor of the Exchequer.
Much of this speculation focused on capital gains tax (CGT), the tax levied on the profit made from the sale of an asset that has increased in value, not least because the Labor Party has not ruled out changes to it.
Rich people selling assets and thinking about leaving the UK
The Financial Times reports today that “some wealthy individuals are selling assets such as shares and property in preparation for a new Labor government that they fear will raise capital gains tax”, citing comments from wealth managers.
It singles out chief executives, business owners and buy-to-let landlords as among those who sell and quotes a wealth manager saying that some wealthy individuals were considering leaving the UK in the event of a significant rise in CGT: “You could see a breakout of brains from people who are building businesses, creating jobs and who have already paid significant amounts of tax in the UK.”
How does CGT work?
CGT is currently charged on most personal assets worth £6,000 or more, including second homes, most shares not held in an ISA and business assets. In some cases, it may also be charged on an individual’s main residence if, for example, the property has been let or has been partially used for business purposes.
But the fact that CGT, which brought in £15 billion to the Treasury last year and is expected to raise £19.5 billion this year, is charged at a lower rate than income tax makes it a target tempting for the Treasury.
Basic rate taxpayers currently pay 10% on capital gains or 18% on residential property and carried interest (a share of a fund’s profits to which the fund manager is entitled).
For higher and additional rate taxpayers – those who pay income tax at 40p or 45p per pound – this rises to 24% on gains from residential property, 28% on gains from carried interest and 20% on gains from other assets taxable.
A tempting target for the Labor Party
These lower rates mean there are big savings to be made for people who choose to disguise their income as a capital gain.
The Labor manifesto explicitly highlights one area where the CGT regime will change – which is for managers working in the private equity industry.
It says: “Private equity is the only industry where performance-related compensation is treated as capital gains. Labor will close this gap.”
The manifesto states that this measure would raise £565 million a year for the Treasury.
There are other reasons why a new chancellor might be tempted to target CGT.
How Labor could make changes to CGT
The International Monetary Fund recently recommended expanding the scope of CGT, although it would be a courageous chancellor to remove the biggest CGT exemption – gains on the sale of a main residence – despite such a measure yielding £25 billion annually.
The most obvious lever to use would be to align the rates at which CGT is charged with the rates at which income tax is charged – something Ms Reeves herself called for in a pamphlet published in 2018.
This could raise between £8 and £16 billion for the Treasury – estimates vary – and was actually done by one of the UK’s greatest reforming chancellors, Nigel Lawsonin its March 1988 Budget.
The measure yielded considerable sums and the agreement remained in force until 2007, when Alistair Querido reintroduced a new flat CGT rate of 18%, well below the prevailing rates at which income tax was charged at the time.
There are good arguments for and against equalizing CGT and income tax rates.
The case for and against equalizing CGT and income tax
The main thing in favor is justice. Those who support increasing CGT argue that it is wrong for someone who makes a profit from the sale of land, buildings, shares or works of art to be taxed more lightly on that activity than someone who works for a living.
The main argument against it is that it punishes wealth creators – the entrepreneurs who take huge risks in creating a company and hiring people. It is argued that they should be rewarded for their efforts and risk-taking.
Another is that CGT – which was introduced by the Labor Party’s Jim Callaghan in 1965 – has always been set below income tax because part of any capital gain will inevitably be due to inflation.
Several chancellors have sought to resolve this issue: Sir Geoffrey Howe introduced an indexation allowance in 1982 with the aim of ensuring that individuals were taxed only on their “real” capital gain and not on the element of it that was due to inflation.
Then, in 1998, Gordon Brown it replaced indexation with a ‘phase reduction’, which ensured that the longer an asset was held, the lower the amount of CGT charged when it was sold. The aim was to distinguish between short-term speculators and entrepreneurs who have built a business asset over many years.
Possible risks
Increasing the CGT rate could also lead to a fall in tax revenue.
The vast majority of CGT, almost three-quarters of the total, is currently earned through taxation on the sale of business assets. And CGT is easily avoided if you don’t sell an asset.
Keep up with the latest news from the UK and around the world by following Sky News
A wealthy individual could do this, for example, by holding an asset until they die (CGT is currently not payable in the event of death) and, if they choose to raise capital from it during their lifetime, by taking out loans against the asset.
And possibly equalizing CGT and income tax would not work today.
This is because – unlike in Nigel Lawson’s time – the top rate of income tax is now 45p in the pound.
Increasing CGT to this level would immediately make the UK CGT rate the highest in Europe. There could also be a risk of brain drain.
The UK is already alarmingly dependent on a very small number of taxpayers: investment platform Wealth Club reported today, following a freedom of information request, that just 100,000 taxpayers – representing just 0.3% of all UK taxpayers – pay a quarter of all income tax and CGT.
Many of these people are highly mobile and are not in the UK because of the weather.
Driving them abroad is not something a chancellor seeking to encourage business and investment to drive growth would want.
This story originally appeared on News.sky.com read the full story
