Why hiking Capital Gains Tax is a bad idea

October 08, 2014 3:28 PM

The Liberal Democrats have proposed an increase in Capital Gains Tax (CGT), currently charged at 28 per cent for higher and additional rate taxpayers. They claim increasing the rate to 35 per cent will raise and extra £500m to fund an increase in the personal allowance in 2015-16.

There are a number of major problems:

It won’t increase receipts:

  • George Osborne increased CGT for higher and additional rate taxpayers from 18 to 28 per cent in his 2010 Budget
  • So given the performance of the stock and property markets (especially London), you’d expect CGT receipts to be soaring. However:
  • With the 18 per cent rate of CGT revenues were £7.8bn in 2008-09
  • But with the new 28 per cent rate in place, CGT receipts have slumped to £4.3bn in 2011-12 and £3.9bn in 2012-13.

The OBR’s forecasts for CGT have been extremely optimistic:

  • Receipts for 2013-14 are expected to be the same as in 2012-13 – £3.9bn. But:
  • In the 2012 Budget receipts for 2013-14 were projected to be £4.9bn: a 20.4 per cent shortfall
  • In the 2013 Budget receipts for 2013-14 were projected to be £5.1bn:  a 23.5 per cent shortfall

Logic suggests the Government’s own calculations would suggest a 25 per rate, not 28 per cent

To increase revenues, rates should be cut

  • Look what’s happened in the United States.
  • The graph below shows Capital Gains Tax rates and revenues in the United States at constant prices. Clearly the rate cuts starting in the early 1990s have boosted revenues.

CGT

CGT severely distorts incentives and gums up markets. Rate hikes will make this even worse:

Consider this example:

  • Danny Davey is considering selling his second home. He bought it a few years ago for £500,000 and now it’s worth £750,000. He thinks now would be the right time to sell as he’ll probably be changing jobs soon and moving out of London. Danny realises there will be 28 per cent charge on most of the £250,000 his shrewd investment has made. But he’s not short of cash and knows that the tax rate has gone up and down in the past so might well come down again in the future, especially a new government that has seen the chart above. He decides not to sell.
  • The Treasury gets nothing. There’s one fewer transaction in the market. Potential buyers would need to buy another property instead and possibly not buy at all, out of fear of being “locked in”.
  • The same logic can be applied to shares and business. CGT has the effect of “locking-in” ownership of assets leading to their misallocation.

It’s a double tax:

  • A company increases its profits and pays more Corporation Tax as a result. This increases the value of shares. This increase is a capital gain which is taxable if the shares are sold.
  • To their credit, the government’s reforms to ISAs have offset some of this for those with modest savings as CGT is not levied on shares held in ISAs.

It’s a tax on inflation:

  • If someone buys some shares for £100 and sells them a few years later for £200, some of this gain is very likely to be inflation. CGT makes no allowances for this, reducing returns and maybe even turning gains into losses.

Lots of other countries don’t have CGT at all:

  • Belgium, Czech Republic, Turkey, Switzerland, South Korea, New Zealand, and the Netherlands to name just a few have no Capital Gains Tax in the same form as the UK’s. High rates put the UK at a disadvantage to these countries in a globalised economy where capital is much more mobile than it once was.
  • All in all, this is an extremely poorly-thought through proposal. The Liberal Democrats have failed to learn lessons from the last few years and are proposing measures that will reduce growth.
  • CGT is an economically destructive tax which leads to the misallocation of assets and discourages entrepreneurship. It should be abolished as recommended by the 2020 Tax Commission.

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