Whichever party emerges victorious in the next general election will be met with challenging decisions regarding taxation and spending, according to the independent Institute of Fiscal Studies. Both Labour and the Conservatives have pledged not to make changes to the main sources of government revenue – income tax, national insurance, VAT, and corporation tax. However, with projected spending already deemed “implausibly tight” by the Institute for Government, it is likely that additional sources of revenue will be necessary by 2025.
If both parties adhere to their fiscal rules and choose not to increase borrowing – though this remains a possibility – it is worth considering the potential methods of raising funds. Labour has already announced plans to raise taxes on North Sea oil and gas producers, as well as implementing VAT on school fees. However, these measures are relatively minor in comparison to the overall government spending. This has sparked speculation about what other options may be on the table for a potential Chancellor of the Exchequer, with much attention focusing on capital gains tax (CGT).
The Financial Times reports that wealthy individuals are already taking action to prepare for a potential Labour government, with some selling assets such as shares and property out of fear of an increase in CGT. According to wealth managers, chief executives, entrepreneurs, and buy-to-let landlords are among those considering selling their assets, with some even contemplating leaving the UK if CGT is significantly raised. One wealth manager states, “You could see a brain drain of people who are building businesses, creating jobs and have already paid significant amounts of tax in the UK.”
Currently, CGT is levied on most personal possessions worth over £6,000, including second homes, most shares not held in an ISA, and business assets. In certain cases, it can also be applied to an individual’s main home if it has been rented out or used for business purposes. However, with CGT being taxed at a lower rate than income tax, it presents an attractive target 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 a fund manager is entitled). For higher and additional rate taxpayers, this increases to 24% on gains from residential property, 28% on gains from carried interest, and 20% on gains from other chargeable assets.
Labour’s manifesto specifically mentions their intention to close a loophole in the CGT regime for managers in the private equity industry, which they estimate would raise £565 million annually for the Treasury. With the International Monetary Fund recommending expanding the scope of CGT, it is possible that an incoming Chancellor may consider aligning the rates at which CGT and income tax are levied. This was last done by Chancellor Nigel Lawson in 1988, bringing in substantial revenue until 2007 when Alistair Darling reintroduced a flat rate of CGT at 18%, well below the prevailing rates of income tax at the time.
There are valid arguments both for and against equalizing the rates of CGT and income tax. On one hand, it could be seen as a matter of fairness, with some arguing that it is unjust for someone who makes a profit from selling assets to be taxed less than someone who earns a living. Others argue that it discourages risk-taking and entrepreneurship, with many entrepreneurs already taking significant risks in setting up a business and employing people. Additionally, part of any capital gain is inevitably due to inflation, which is why CGT has traditionally been set lower than income tax. Previous chancellors have attempted to address this by introducing measures such as indexation and taper relief.
However, raising the rate of CGT may also result in a decrease in revenue. The majority of CGT – almost three-quarters – is currently generated from the sale of business assets, and it is easily avoided by not selling an asset. Wealthy individuals may choose to hold onto their assets until they pass away, as CGT is not charged on death. They may also choose to raise capital by borrowing against their assets during their lifetime. Furthermore, equalizing CGT and income tax would make the UK’s CGT rate the highest in Europe, potentially leading to a brain drain of highly mobile, high-net-worth individuals.
The UK is already heavily reliant on a small percentage of taxpayers, with just 100,000 individuals contributing a quarter of all income tax and CGT. Many of these individuals are not in the UK for the weather, and driving them abroad would not be beneficial for a government seeking to promote entrepreneurship and encourage investment for economic growth. Ultimately, any decision to increase CGT rates will require careful consideration of the potential risks and benefits.
