Worrying signs of a Lib Dem cave-in on capital gains tax

Green Politics

Dropping progressive manifesto commitments just because they happen to offend the right wing of the Conservative party are becoming a depressingly regular feature of the new administration.

Our guest writer is Howard Reed, director of the economic research consultancy Landman Economics

Before 2007 capital gains tax (CGT) – a tax levied on the proceeds from the sale of capital assets in the UK – had a structure with a headline rate of 40 per cent (the same as the top rate of income tax at the time) combined with a taper system whereby the longer someone held an asset, the lower the rate of CGT had to be paid on it when disposing of it.

This system was widely held to be too complex and was replaced in 2007 by a flat rate of 18 per cent (with an additional ‘entrepreneur’s relief’). The 18 per cent rate was designed to encourage entrepreneurs to build up their own companies without fearing high rates of tax when they sold them later on.

But both the pre-2007 and post-2007 systems had the drawback that they encouraged people who could receive their remuneration in capital instead of income (eg. many of those working in the financial services sector, such as hedge fund or private equity partners) to do just that, meaning that many of the UK’s wealthiest businesspeople paid a lower highest marginal rate of tax – 18 per cent – than people on low-to-medium incomes who faced a marginal income tax rate of 20 per cent. This made a mockery of the concept of tax fairness.

The Liberal Democrats’ election manifesto contained a sensible and progressive proposal to solve this problem – aligning Capital Gains Tax (CGT) with marginal rates of income tax “so that all the money you make is taxed in the same way”. When the Liberal Democrats went into coalition with the Conservatives the CGT proposal was retained even though many of the Lib Dems’ other progressive tax commitments (e.g. the “mansion tax”) were dropped.

However, the proposal has predictably outraged many on the Tory right, with senior figures such as David Davis and John Redwood lobbying against it. Industry groups such as the British Chambers of Commerce have also opposed it. In response to these criticisms from its own heartlands, there are signs that the coalition government will water down the Lib Dem proposals by returning to the pre-2007 taper rate structure, whereby individuals pay a lower rate of CGT the longer they hold assets for.

This would be a big mistake. The evidence from the pre-2007 system is that the taper structure creates distortions between different forms of investment and opens up a huge disparity between people working in businesses where remuneration can be taken as capital gains and those where it has to be taken as income.

Tapers are also a badly targeted means of encouraging entrepreneurship as many people who aren’t entrepreneurs, but are able to hold their assets for several years before disposal, get the lower rates. And there are better – and cheaper – ways of encouraging investment through the tax system than having a lower CGT rate. As the Institute for Fiscal Studies looks set to recommend in its Mirrlees Review of the tax system (see a speech by IFS’s Paul Johnson on the subject here), capital allowances are a much better way of supporting investment in small businesses.

If the coalition’s CGT proposals are watered down for a return to the problematic pre-2007 system it will be a victory for right-wing dogma and against good sense on tax policy. Liberal Democrat cave-ins on important aspects of policy – dropping progressive manifesto commitments just because they happen to offend the right wing of the Conservative party – are becoming a depressingly regular feature of the new administration.

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19 Responses to “Worrying signs of a Lib Dem cave-in on capital gains tax”

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  2. David Reilly

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  3. Pete Phillips

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  4. John West

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  5. Trakgalvis

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