We now know for sure that the nation faces a huge hole in its public finances. So amidst an economic crisis that has opened wider the social divide between the haves and have nots, a rise in capital gains tax to 40% seems to be an especially easy sell. After all this levy on second homeowners and rampant speculators is designed to fund a laudable income tax cut for the lowest earners. However taxing capital gains and income differently is not an anomaly.
Like many MPs, I have received an avalanche of letters and emails from angry and perplexed constituents since the rise in CGT was floated. These do not come from the ranks of the super wealthy or short-term City speculators. Instead my anxious correspondents are predominantly people who have ‘done the right thing’ – those who have worked to build a business up, employees who invested in their company; workers close to retirement who have painstakingly acquired small share portfolios or those who, having lost trust in the pensions system, turned to property as a safe haven for their retirement fund. In short, rather than representing a neat redistributive tax from rich to poor, the proposed rise in CGT risks squeezing those caught in the middle and stifling aspiration and self-reliance to boot.
Capital gains tax is a levy on the gain or profit you make when you sell or otherwise dispose of an asset, such as shares or property. In addition to an annual CGT allowance (currently £10,000) and Entrepreneur’s Relief, in the past taper relief (which modifies the levy according to the length an asset has been held) and indexation (the taking into account of inflation) have offset some of the burden placed upon individuals.
Capital gains have hitherto been taxed at a different rate from income for good reason. They come from investment and those investments inevitably involve risk – risk that does not necessarily deliver a return. Indeed given the current state of the economy, there is no guarantee that investing in shares or property will prove as beneficial in the future as it has been. Reduce further the incentives to make those investments in the first place, therefore, and you will find there are some unwelcome knock-on effects.
First, strong and growing economies depend upon high levels of investment. These have to be financed out of savings and the existing pool of capital. The UK has a serious problem already in this respect because our savings ratio has slumped to around 5%, compared to 35% in fast growing economies such as China and India. Accordingly in the UK we will have to depend on our current pool of savings and inward investments (which will result in ever more dividends and interest being sent overseas to the detriment of our own living standards). Higher levels of Capital Gains Tax will only serve to reduce further the pool of savings available for future capital investment. Indeed, yet more of the UK’s capital risks being used to fund current expenditure – a state of affairs that will continue for so long as we continue to run a deficit.
Second, capital is highly mobile. For that reason economic competitors of the UK’s such as Australia, New Zealand, Switzerland and the Netherlands, have abolished capital gains tax. All these countries recognise that high capital gains tax rates discourage investment.
CGT also clogs up the capital markets. Nobody is compelled to sell an asset so uncompetitive rates of CGT will simply encourage those who do not need to realise their gains to switch into other assets or securities. As such, there is a real risk that any sharp rise in the rates of CGT will produce a precipitate drop in the government’s tax take from this source. Aligning capital gains tax rates with those of income tax will most likely worsen the deficit as it will cost revenue to the Exchequer.
Moreover, high rates of CGT reduce turnover and liquidity levels in the stock market. In turn the most successful growing companies will find it more difficult and expensive to raise capital to the detriment of the UK economy as a whole. Naturally this also applies to foreign companies who have traditionally looked to the City of London to raise money for expansion.
Having been overwhelmed by individual respondents, I convened a meeting in parliament last week with representatives from the Institute of Directors, National Landlords’ Association and the UK Shareholders’ Association to test the breadth of concern over capital tax rises. Nearly every representative accepted the inevitability in the current economic plight of an uplift to CGT, but raised wide-ranging worries – the general competitiveness of the UK economy and the problems of uncertainty in the financial environment; the constraining effect on the private rented sector that stands to affect young renters and social housing tenants; the penalising of the small investor; the impact on company share schemes and mobile talent; the perverse message being sent out to pensioners and those saving for retirement.
If the headline rate is to remain, all representatives pushed for softeners, namely the reintroduction of taper relief or a return to indexation. This may be the only way yet seems contrary to the laudable aim of simplification in our tax system. In his famous 1988 Budget the then Chancellor, Nigel Lawson, brought into line the level of CGT with basic and higher rates of income tax. This was achieved at a time of aggressive reductions in the latter. Similarly two years ago Alistair Darling introduced a flat rate of 18% by removing indexation and taper relief.
Restoring a complicated regime of allowances and reliefs to take account of the effects of inflation and length of time over which chargeable assets has been owned sadly might prove an unavoidable compromise to part-protect the interests of the prudent and the elderly, long-term investor.
Whilst the new Business Secretary, Vince Cable, assures us that the proposed higher rates of CGT are not aimed at entrepreneurs, but are designed at ‘essentially private capital gains, financial capital gains and second homes,’ he perhaps fails to appreciate fully that many second home owners have sought to save in such an asset as a consequence of the widespread lack of trust in pensions and other financial products over the past couple of decades.
Similarly, he seems not to have taken into account the disproportionate impact higher rates on property will have on Londoners and those in the Home Counties. Many people who buy a second home outside the capital as an extensive to a small London base do so not because they are enormously wealthy but precisely because they are not. It is virtually impossible even for many of those earning multiples of the average national wage to trade up the property ladder in the Capital. For those with growing families, the only option is often to buy a house with garden outside London.
Above all, an increase in the rate of capital gains may in the event generate neither fairness nor additional revenue. Our nation more than ever needs to be able to repay its debts by wealth creation and selling our skills, products and expertise in a highly competitive global market. This cannot be done by disincentivising small businesses and entrepreneurs with higher tax for risk and investment now or by punishing those who have done the right thing by saving for their future.