Whoever wins the next general election will face extremely tough choices on taxation and spending.
An independent fiscal research institute It pointed outboth Labor And that conservatives The four major sources of revenue are income tax; National InsuranceVAT and corporate tax.
And while both parties have pledged relatively modest spending, current spending plans already scheduled for 2025 (which the Institute for Government has called “incredibly tough”) will almost certainly mean revenue will be needed from other sources.
How will the new government raise the funds?
Both parties have existing Financial Regulation And if they choose not to increase borrowing (which is certainly a possibility), it is worth considering what measures could be taken to raise revenue.
The Labour Party has already confirmed it is planning several revenue-raising measures. Most notably: Tax on North Sea oil and gas There are taxes on producers and value-added tax on school tuition fees, but these are very small parts of overall government spending.
This has led to intense speculation as to what the alternatives might be. Rachel Reeves It's a role she may take on if, as expected, she becomes finance minister.
Much of the speculation has centred on capital gains tax (CGT), which is levied on profits made from the sale of assets that have appreciated in value, and because Labour has not ruled out changing it.
Wealthy people considering selling assets to leave the UK
The Financial Times reported today, citing asset managers, that “some wealthy people are worried a Labour government will raise capital gains tax and are selling assets such as stocks and property in preparation for this.”
The report singled out chief executives, entrepreneurs and rental property owners as targets for selling, with one asset manager saying some wealthy people were considering leaving the UK if capital gains tax was significantly increased: “We could see a brain drain of people who are starting businesses, creating jobs and already paying large amounts of tax in the UK.”
Reeves asked about raising taxes
How does CGT work?
Currently, capital gains tax is levied on most personal property worth more than £6,000, including second homes, most shares not held in an ISA, business assets, etc. It can also be levied on a person's main residence if, for example, the property is rented out or used partly for business purposes.
But capital gains tax generated £15 billion for the Treasury last year and is expected to rise to £19.5 billion this year, and its lower rate than income tax makes it an attractive target for the Treasury.
Basic rate taxpayers currently pay 10% on capital gains and 18% on residential property and carried interest (the part of a fund's profits that the fund manager is entitled to receive).
For higher and additional rate taxpayers (those who pay income tax at 40p or 45p in the pound), the rates rise to 24% on profits from residential property, 28% on profits from success fees and 20% on profits from other taxable assets.
An attractive target for the Labour Party
These lower tax rates mean significant savings for people who choose to disguise their income as capital gains.
Labour's manifesto explicitly lists changes to managers working in the private equity industry as an area for changing the capital gains tax regime.
“Private equity is the only industry where performance-related pay is treated as capital gains. Labour will close this loophole,” it says.
The manifesto says the measures could raise £565 million a year for the Treasury.
There are other reasons why the new Chancellor of the Exchequer might want to target CGT.
How Labour could deliver capital gains tax reform
The International Monetary Fund recently recommended expanding the scope of capital gains tax, but it would be brave of the Chancellor to abolish the largest exemption from capital gains tax – profits on the sale of one's own home – even if such a measure would raise £25 billion a year.
The most obvious step would be to bring capital gains tax rates in line with income tax rates, something Reeves himself called for in a pamphlet he published in 2018.
This could raise between £8 billion and £16 billion for the Treasury (estimates vary), and it was undertaken by one of the UK's most reformist finance ministers. Nigel LawsonThis was stated in the budget proposal of March 1988.
This raised a significant amount of money and the arrangement continued until 2007, when Alistair Darling It reintroduced a new flat capital gains tax rate of 18%, significantly lower than the then-current rate of income tax.
The arguments for and against equalizing capital gains and income tax rates are compelling.
The pros and cons of equalizing capital gains and income taxes
The main argument for its support is fairness: Supporters of higher capital gains taxes argue that it is wrong for people who make a profit from the sale of land, buildings, stocks, or art to be taxed less heavily for those activities than people who work to earn a living.
The main argument against the system is that it punishes wealth creators – entrepreneurs who take big risks in starting businesses and employing people – who should be rewarded for their efforts and the risks they take.
Another is that capital gains tax, introduced by Labour's Jim Callaghan in 1965, has always been lower than income tax because some capital gains are inevitably due to inflation.
Various Chancellors have tried to address this issue: Sir Geoffrey Howe introduced indexation in 1982, which aimed to ensure that individuals were only taxed on their “real” capital gains, rather than the component due to inflation.
And in 1998, Gordon Brown He replaced indexation with “tapering relief,” which meant that the longer you held an asset, the lower the capital gains tax you had to pay when you sold it, in order to distinguish between short-term speculators and entrepreneurs who had built up business wealth over many years.
Possible risks
Increasing the CGT rate could also result in a reduction in tax revenue.
Currently, the majority of capital gains tax – about three-quarters of the total – comes from taxes on the sale of business assets, and capital gains tax can easily be avoided by not selling assets.
Wealthy individuals, for example, can hold onto their assets until they die (currently there is no capital gains tax on death) and, if they choose to raise capital from those assets during their lifetime, they can do so by borrowing against those assets.
And perhaps equalizing capital gains and income taxes would not work today.
That's because, unlike in Nigel Lawson's time, the top rate of income tax is now 45p in the pound.
Raising capital gains tax to this level would quickly make the UK the highest in Europe – and it would also risk a brain drain.
The UK is already shockingly reliant on a very small number of taxpayers: investment platform Wealth Club reported today, in response to 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 capital gains tax.
Many of these people are highly mobile and are not in the UK due to the weather.
Pushing them overseas is not what the finance minister wants as he is trying to encourage entrepreneurship and investment to boost growth.
