Capital Gains Tax: Is it justified?
Updated on 21 June 2010
Will the Government increase Capital Gains Tax in tomorrow’s emergency Budget? But, as tax partner with UHY Hacker Young, Roy Maugham writes a rise in CGT could stifle entrepreneurship and the minimal benefit for the Treasury does not seem to justify a hike.
There has been a lot of ink spilled over whether tomorrow's emergency budget will see a rise in Capital Gains Tax (CGT).
Would hiking CGT to 40 per cent or 50 per cent have a disastrous affect on investment? Would the resulting benefit for the public finances be significant enough to justify such a policy?
Taking a closer look at the figures, the increase in CGT does not seem the best way for the government to achieve its fundraising ambitions.
The suggestion is that the coalition government is considering raising CGT on non-business assets from 18 per cent. This would align capital gains tax with marginal rates of income tax, meaning that CGT could increase to as high as 50 per cent from tomorrow.
It is argued that the current wide gap between CGT and income tax encourages taxpayers to convert income into capital gains, potentially costing the Treasury millions in tax avoidance. So from the coalition Government's point of view, raising the CGT rate may be an effective way of reducing tax avoidance.
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On the other hand, a hike in CGT could seriously jeopardise the long-term health of Britain’s enterprise economy by severely damaging the flow of funding from private investors into new and developing companies.
According to research by UHY Hacker Young based on the latest ONS statistics, the number of new businesses being created in the UK dropped by 12 per cent to 8 businesses per 10,000 population in 2008.
Small and medium businesses are the backbone of the UK economy, so do we really want to raise tax in a way that deters entrepreneurs from investing in them?
It is likely that if the Government decides to increase CGT it will introduce measures to mitigate the impact of the increase on start-ups and private investors. These could mean leaving entrepreneurs relief at 10 per cent and introducing a time based rate of tax so that short term gains are taxable at the marginal rate of income tax whilst a taper is introduced to allow assets held for longer periods to be taxed at a lower rate.
This approach may also pacify those nearing retirement who have invested in property following the various attacks by the former government on pension schemes or premiums.
What might the budget bring?
John Whiting, tax policy director of the Chartered Institute of Taxation looks ahead for Channel 4 News:
• Income tax – there will be a "significant step" towards the promised £10,000 personal allowance (i.e. the yearly amount of income an individual can have before income tax bites). Currently £6,475, an increase of £1,000 from next April (worth £200 to basic rate taxpayers) is on the cards.
• National insurance – the 1 per cent rise in all rates announced by the previous government will go ahead; there is a promise of help for employers through an adjustment to the point at which employers start to pay NICs on their employees’ pay, but it seems that employees and self-employed will see part of that income tax benefit clawed back through increased NICs.
• Capital Gains Tax (CGT) – the current 18 per cent tax rate will increase to something "closer to income tax rates", with "generous relief for entrepreneurs". This seems likely to mean a 40 per cent rate for higher rate taxpayers, 20 per cent for basic rate payers (but gains may push them into the higher rate bracket). Key issues are: from when (hopefully not before April next year); what gets the "generous reliefs" (undoubtedly own businesses, but what about shares in employers?); and what about relief for inflation?
• Benefits – expect some more details of how tax credits are going to be restricted for higher earners, possibly by scrapping the £545pa "family element". Curtailment of child trust funds will probably be confirmed as well.
• Stamp duty – the coalition have said they would like to make permanent the current temporary relief for house purchases up to £250,000 by first-time buyers. This runs until March 2012 so it’s more likely to be a subject for next year.
• Business taxes – cuts in the main rate of corporation tax from the current 28 per cent have been promised, but the plan to pay for them with cuts in capital allowances and reliefs has upset those (manufacturers especially), who would lose out, so may go out for further consultation.
- Read John Whiting's full analysis
Capital Gains Tax only represents one per cent of the government's overall revenue from tax. According to HM Revenue and Customs, CGT receipts amounted to just £2.5bn in 2009/10 compared to a total tax revenue of £397bn.
In light of this, even a hypothetical increase to a rate of 50 per cent would be a drop in the ocean and have a negligible impact on reducing the public sector deficit.
These figures reveal how marginal the financial benefit would be for the government in increasing CGT tomorrow. What this also highlights is how CGT has become a political football with which politicians are desperately trying to score points against each other.
One thing is clear: whilst a rise in CGT could stifle entrepreneurship, the minimal benefit for the Treasury does not seem to justify it. The government perhaps ought to look to other taxes as part of its deficit reduction programme.
