Capital gains tax reform is one of the biggest issues currently facing the Coalition Government; there is a major debate taking place on how the tax can be reformed & made fairer.
Capital gains tax reform is one of the biggest issues currently facing the Coalition Government; there is a major debate taking place on how the tax can be reformed so that it is fairer, brought more in-line with income tax rates, and crucially, how it can stop being an avenue for tax avoidance – its biggest weakness.
The debate is intense, with proposed measures being vigorously defended and rubbished before they have even been officially unveiled. The analysis below attempts to provide some clarity on this highly-contested area with a closer examination of the main issues at stake and policy measures being muted.
This is the key problem: In April 2010, the new 50 per cent income tax rate for earnings above £150,000 was introduced. With CGT no longer aligned with income tax rates (changed in April 2008, to a flat rate of 18 per cent) the incentives to transfer earnings from income to capital gains has never been so strong.
The wide discrepancy and distortion between the two taxes have led to significant accounts of tax avoidance. Private equity firms have particularly been keen to exploit this, along with some small business holders. This is because they are able to forgo some of their salary, and invest the money into their business.
When it comes to selling, or part-selling their business, they would be liable to capital gains tax, rather than income tax, thereby avoiding paying huge sums of money in tax. Private equity firms are able to do similar things with share options and through employing expensive accounting procedures.
One MP revealed that a billionaire equity fund manager has to pay lower rates on his unearned income (18 per cent) than a hard-working individual on the minimum wage (who would find some of their earnings subject to a 20 per cent) rate. The case for reform is clear.
This is the current situation: One of the key Liberal Democrat pledges agreed on in the Coalition Government’s programme was to reform the tax system, by initially increasing personal allowances to £10,000 (a highly regressive policy, as explained in detail by Left Foot Forward), funded through departmental cuts on ‘waste’ and raising CGT rates.
The plan is to align CGT rates on non-business assets to income tax levels while re-introducing indexation allowances, thereby taxing the gains on asset appreciation in real terms. They have no plan to bring back taper-relief for businesses, which only serves to increase distortion and potential loopholes.
However, in the past few weeks Conservative rank & file members, along with backbench parliamentarians, have been voicing their opposition to any such move without significant exemptions, notably the re-introduction of taper relief. A campaign is being led by the former Cabinet minister, John Redwood, who has been arguing that 5-year-rated taper relief be introduced alongside any change to headline CGT rate changes.
Under his plan, the longer an asset is held, the lower the CGT rate, with a zero per cent rate after five years, which would:
“Send a strong signal to the world’s investors that the UK is back in business as a favourable location.”
He further claims that he has:
“Been swamped with support for these suggestions, both from around the country and from Conservative MPs.”
Indeed, it appears his campaign is having some success, with reports emerging that Chancellor George Osborne is set to announce major and widespread exemptions in his emergency budget on June 22. Taper relief is now being actively considered, alongside a full exemption from CGT liability for those aged over 65. How progressive is this?
Re-aligning CGT rates with those on earned and dividend income has been welcomed by several progressive voices and opinions, who equally supported the move to abolish taper relief in 2008. By creating a simpler system with the distortionary incentives removed, CGT can become a fairer tax. The director of Institute for Fiscal Studies, Robert Chote, has recently stated that:
“Different tax rates encourage people to be paid in more lightly taxed forms and to move into occupations where this is easier.”
He further argues against the Tory proposals to differentiate between business and non-business assets, through favouring the former:
“People should be left to decide unbribed whether to put their money into a bank account, housing, shares, or into their own businesses, based on their own judgement of the risks and returns involved.
“We should be wary of the argument that investing in one’s own business is virtuous and deserving of subsidy in a way that investing in somebody else’s business is not.
“People should decide whether and how to build an enterprise on the basis of its commercial fundamentals, not its tax treatment.”
Mr Chote also makes clear that people shouldn’t be pushed or incentivised into holding assets longer than they would wish to do:
“Economic welfare is best served by having assets owned by the people who value them most.”
The core of his message is that we should seek to remove the distortions and unjustifiable exemptions, and encourage investment, enterprise, and a culture of savings through better targeted allowances and initiatives – ie. capital allowances for manufacturing – that the Tories have hinted are to be drastically cut.
The debate on CGT reform needs to be focused here, not on the principle of the CGT itself.
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[…] any rise in CGT (even though this rise looks as though it will be modest to say the least) – Left Foot Forward have a good blog about the regressive impact these measures would […]