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The government must cut or even scrap capital gains tax

26 February 2013

When economists get things wrong– something rather easy, given the nature of their subject – they should admit that they got them wrong. Well, the Adam Smith Institute got it wrong. Two years ago we predicted that, if Vince Cable got his way and capital gains tax rates were increased to match income tax rates – up from 18 per cent to 40 per cent or even 50 per cent – the Treasury would not make anything out of it, and would actually lose £2.48bn in revenue.

In the event, CGT was not raised to 40 per cent or 50 per cent. But it was raised to 28 per cent from 18 per cent for most asset sales. (The entrepreneurs’ rate, designed to encourage people to build up lifelong businesses, remained at 10 per cent.) The result? The Treasury is about £4.9bn worse off than it was before. We were wrong, but only in terms of being far too conservative about the revenue losses that a tax hike would bring. It is time to bring CGT back down to more realistic levels – levels that would encourage people to invest in the UK and in UK businesses and maybe help get us out of our downrated, deficit-dominated doldrums.

The CGT rise came in on 23 June 2010 – unusually, 78 days into a financial year. That was how keen Vince & Co were on it. That is good and bad for economists, as it makes it possible to see how the receipts changed within the same year, though it does make the arithmetic a little trickier. What actually happened is that, on an annualised basis, CGT raised £8.2bn before 23 June 2010, and just £3.3bn afterwards. We told you so, though we didn’t tell you loud enough.

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I am sure that high-taxing ministers will brush off much of this difference by saying that because people could see the hike coming they decided to sell off assets before they got hit with the extra tax. And indeed, normal disposals were down 76 per cent after 23 June 2010. Perhaps more surprisingly, entrepreneurs’ rate disposals were also down by 34 per cent – meaning that even people running lifetime businesses got out before the tax changed, just in case they were hit too.

That indicates two things. First, just how far people will go to avoid this tax, particularly when it is levied at rates they feel are simply unfair. After all, much of the capital ‘gain’ that a long-term investor makes is simply inflation, and inflation has been running high for some time. People naturally resent paying tax on ‘gains’ that are not in fact real.

Second, it indicates just how far CGT is a voluntary tax. Very few people are forced to sell assets. If they figure that they will be socked by a big tax, and that the money they will get for their assets will keep losing its value, they will hold on to them, and maybe wait for a change of policy that brings in lower taxes and less inflation. The only people who are forced to sell assets are those like pensioners who build up lifetime savings and then need to sell them to fund their retirement, or expensive episodes of medical or social care.

So high rates of CGT are bad for the Treasury, bad for the ordinary saving public, bad for business investors – and therefore bad for the country. It is time to send out a message that the UK is committed to being a low-tax country, and reduce or even get rid of this damaging tax.

Eamonn Butler is Director of the Adam Smith Institute.

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  • Mick

    Andy spot on! And to those who say benifits to those who need them, why should I pay or in fact anyone else pay for someone on benifits? I have always had this veiw even when I first started working at 15. Why should someone else pay for me, if I can’t be bothered working or I make excuses up of why I can’t work more or educate myself?? Benifits are a emergency safty net that is/has been erroded by the very large benifits for life majority! If I was to loose my job tomorrow I would have to eat through my savings that I have spent years carefully.planning, I would then not be entitled to sod all, eventually after loosing my house I would be able to claim job seekers.where if I pissed it up.the wall and had nothing, been socially irresponsible and had 5 kids I would.get everything handed to me! Why? Why should anyone pay for me and why should I pay for them? Why am I now going to be taxed an extra 7.5% on my dividends because I run my own company! I already pay out tens of thousands in tax why is it my responsibility to pay for some lazy moaning, its everyone else’s fault bar mine! Anyway I agree capital gains tax should be.binned when pare people going to realise you can not attack big business and investors in this day and age, if you do they don’t invest, cut jobs and go else where! Who’s then!

  • Paul J

    Ah, the Adam Smith Institute, the only institution in the UK which thinks Brits are as dumb as rightwing Americans.
    In lalalalalalala land, tax cuts pay for themselves. In the real world, of course, they don’t.

  • FF42

    Your theory is that at a 28% rate the vast majority of people make sure to avoid the tax, whereas at 18% they don’t bother. Unlikely. I think there are other explanations.

  • CharlietheChump

    CGT was always just another socialist envy tax aimed at making capitalism unattractive.
    It should be abolished.

  • itdoesntaddup

    CGT behaviour is a little more long lasting than suggested here. The
    “Darling Special” of an 18% flat rate caused many to crystallise gains,
    and produced the largest tax take ever for CGT of £7.9bn, as against an
    actual £3.6bn in 2010/11. Gains already crystallised will not be taxed
    in future years: the Darling giveaway brought forward revenues.

    is paid almost exclusively in January and February. This year, January
    receipts were down to £2.8bn compared with £3.3bn last year. There are
    other reasons why revenues are lower: asset prices are not surging as
    they were any more, so fresh gains are not being made. That is a good
    thing where houses are concerned. It is less good where equities are
    concerned, because it implies economic sclerosis. It is the sclerosis
    that needs to be fixed – even if falling house prices might give some a
    CGT shelter.

    However, the most iniquitous feature of CGT is
    that it isn’t a tax on capital gain, but rather a swingeing wealth tax
    on the realisation of long held assets, because there is no form of
    indexation relief. Many people would be better off not selling assets
    and crystallising a tax bill, but borrowing against the assets instead,
    and paying interest.

    Those calling for wealth taxes – we
    already have one, and it isn’t working. Instead, it acts to prevent
    capital from being channelled towards the most productive uses, and
    ensures that landlords remain invested in property on a ratchet system.

    The first CGT reform should be to restore proper indexation relief.

    a useful idea would be to exempt landlords from CGT if they sell
    property to an owner-occupier. That would mean they would achieve the
    same net price by selling at 28% less than another landlord would pay.

    main function of CGT should be to prevent schemes that convert income
    to capital gain as tax avoidance. Anything else, and it becomes sand in
    the economic gearbox.

    • Andy

      Exactly. You ‘get it’ ! We did not tax capital gains until 1965 and I don’t see that there has been any benefit from doing so. If we can increase the return on Capital that should stimulate investment and jobs and tax revenue.

  • El_Sid

    Umm – can you provide sources for the figures? Not doubting them, it’s just good practice. The big hole in the argument is that it completely ignores the fact that people made huge amounts of money in the recovery of 2009. Even as late as 23 June 2009, the FTSE opened at 4234, by 23 June 2010 it was 5247 (+24%) having been over 5800, and by 23 June 2011 it was 5773 (+10% since June 2010, or down since April 2010). Other markets showed even bigger capital gains in 2009/10, but there were just a lot fewer gains being made in 2010/11.

  • 2trueblue

    Another example why we should not listen to the LibDums.

  • Makroon

    It should be easy enough to convince the LibDems to take CGT back down to (say) 15%, with the increased revenue used to raise personal allowances or fund NI concessions for SMEs.

  • Andy

    Capital Gains Tax should be abolished – Today. We should slash Corporation Tax to 10% – Today. And we should announce the intention to go to a Flat Tax of 20% within 3 years.

    To help all this along ‘pensioner benefits’ should go and so should child benefit, which should be abolished in 9 months time (from Today) for any child born after that date and phased out for the rest. We should reform Tax Credits, which are merely a way to make everyone vote Labour. And that will do for tonight.

    • Tom Tom

      Pensioner Benefits are simply tokens to compensate for the worst State Pension in Western Europe

      • Andy

        No they are not. They are silly ‘bribes’ to the electorate and their cost a totally out of proportion to the benefit they give.

    • Tom Tom

      You really want to see high earnings turned into capital gains ? Fine…do a Mitt Romney, what was his tax rate 19% ?

      • UlyssesReturns

        CGT – 20%
        VAT – 20%
        Income tax – 20%
        Tax Credits – 0%
        Child Benefit – 0%
        Housing Benefit – 0%
        Tax evasion – 0%
        Benefits to those who need it at minimum living wage.

        Problems- solved

        • steakfrites

          At what point would one start paying incoming tax? Still at £10k p/a or higher?

          • UlyssesReturns

            Good question – income tax should start at minimum living wage which is around £14,000 which should also be the point at which pensions should be taxed at 20%. Pension contributions would not attract any tax-free benefit. Employees NIC should also be 0% and employers’ NIC should be at the flat tax rate of 20% with no ceiling.

  • Archimedes

    We have corporates with a huge amount of cash building up. It’s not tax that’s stopping them spending. I don’t see why political capital should be wasted on this. There are more important issues to tackle.

    • HookesLaw

      Yes, only result in more anti rich propaganda. But its a good advert really for not having a coalition. Another LD fail.

  • Russell

    Or the government could really help the poor low pay PAYE sufferers, by raising the personal allowance to at least £15000 and cap the maximum benefit figure to something realistic like £15000 (not £26000 tax free!). All the extra pounds in their pockets would be spent coping with increases in energy price rises and petrol/food increases plus help the economy.
    I suppose that would be considered too fair, when the banks can be further baled out with QE, and individuals already rich can make even more money with a CGT reduction.

    • an ex-tory voter

      The Capital Gains Tax increase use resulted in a reduction of the tax collected from “the rich”. This shortfall will have to be paid by the “PAYE taxpayer” in the form of income tax, NI, fuel duty, alcohol tax, tobacco tax, VAT, energy tax, death tax, prescription fees, etc etc etc. In what way is this fair?

      • Tubby_Isaacs

        How do you know it resulted in a reduced tax take? Private equity profits were subject to CGT, when (seeing it was what they did, as their trade) it was more akin to income. With the raise in the CGT rate, that way of arranging business has become less attractive. That doesn’t mean that the business hasn’t taken place at all.

        In fact, how do we know Butler isn’t getting paid by private equity for this column? His organisation don’t reveal their funders.

        Until they do so, they should be ignored.

        • Daniel Maris

          I would certainly agree Butler and the ASI should be ignored – they’re the ones who love mass immigration remember and think it benefits our country!

          CGT is a very minor issue in comparison with increasing your population by 20 million and all the other consquences of mass immigration.

          Instinctively I don’t like the CGT since it seems designed for avoidance and evasion. FTTs are probably better, along with property tax, and higher inheritance taxes.

      • Russell

        Rubbish. CGT is still cheaper than Income tax for the rich, and will be used to avoid tax. The reduction in tax take was obviously going to occur after many took advantage of the low rate, but that was a one-off higher tax take year..

    • FMarion

      I’m not sure whether (1) you didn’t actually get around to reading the article before commenting on it; (2) you didn’t comprehend that the article argues that a capital gains tax cut would generate more revenue (which could pay for some of those things you think are “fair”); or (3) it is more important to you to see the “rich” punished with high tax rates than to increase the government’s revenue take.
      Whatever the explanation, the net result is that your argument makes utterly no sense in the context of this article. Now, I’d argue that your contention also makes utterly no sense in the context of economics, justice or human nature either (unlike a leftist, I think all three are necessarily interrelated), but that is an argument for another day.
      Today’s point is simple. The article shows that by raising the CGT the government threw away billions of pounds in revenue because people don’t have to realize capital gains.. Billions. If it had expanded on the point further, it could have also fairly argued that a lower CGT permits more capital formation, investment and jobs. And even leftists are supposed to believe that jobs are better for people than hand outs.
      So the question for you–and the rest of the left–is whether you’d prefer the government get the revenue or whether you’d prefer it to forgo the revenue in order to smash the “rich.”
      To put it another way, are you really driven by (a) concern for the poor or (b) hatred for the rich?

      • Russell

        First things first. I am not from the left . I have voted ‘proper’ Conservative all my life until now, when I must change to UKIP because of the Cameron/Party position on pro EU, and the fact that they have not/are not addressing the huge public sector spending bill.
        Fact – It generally is only rich people who are due to pay CGT (or people who have assets which have appreciated many times over like property, i.e. unearned income), and as pointed out by another poster, the reduction and large one-off increase in revenue was simply people taking advantage of that one-off cut and will not be repeated by reducing it again, so the current tax take may stay about the same whatever the rate is now.
        People who benefit by taking CGT instead of Income tax don’t necessarily invest that money in UK jobs/puchases, whereas the people who really need some tax relief like the lowest paid WORKERS, would spend all extra money they receive from any tax reductions.
        The ‘rich’ never get smashed as you put it, which is why they have an army of accountants and tax advisors/tax dodges.
        If the ‘rich’ paid the tax which they are expected to pay, we would all be better off. Same as one man businesses set up as limited companies with the wife paid just enough to keep her in 20% tax rate for doing nothing and dividends paid out to avoid higher income tax rates.

        • Andy

          I assume you pay higher rate income tax yourself ??

          When you sell your house (if you own it) you will be paying Capital Gains Tax I assume because it has ‘appreciated many times over’ which is ‘unearned income’ ?? And if not why not.

          And who are these ‘rich’ you keep talking about ? I don’t see millions of them walking down the street. So just exactly who do you consider ‘rich’ that you want to tax, tax and tax.

          • Russell

            I have paid higher rate Income tax during my 44 years of working.

            I bought my house (cash) and have no intentions of selling it, as I bought it as somewhere to live without having any worry about having to move from rented accommodation due to the circumstances of a landlord.
            The rich I am talking about are the people who use CGT as a way of avoiding Income tax, and include many people who most would not count as rich, who set themselves up as limited companies to boost their wealth by avoiding Income tax and NIC like the millions on PAYE using dividends, paying deliberately low salaries to family members to avoid income tax. People who use Trust Funds like the hypocrit Hodge to avoid inheritance tax etc.
            I want lower income tax, for low paid earners and high paid earners and a much simpler tax system..

            • FMarion

              We agree on lower and simplier taxes. Now let me present you and example about the complexities of the CGT issue. Let’s suppose that you bought that house for 100,000 pounds in 1975. And let’s say you sell it tomorrow for 500,000 pounds. You have a nominal gain of 400,000 pounds. What is the “fair” rate of tax on that?
              It’s a bit of a trick question, because 100,000 pounds in 1975 would now be worth 821,000 pounds due to inflation. (at least according to an internet calculator that I used). Thus, on an inflation-adjusted basis you have lost money, and in fairness you should get some sort of deduction for that loss. To actually be forced to pay any tax on what in fact is a loss is utterly unfair because you don’t have any real “income”–yet it is done all the time.
              Now, let’s make this a bit more complex. Rather than selling the house and paying the tax, you decide to borrow against the value of the house and lease it out to someone. You could probably borrow 350,000 comfortably and your lease income will probably offset your interest and other running costs. You now have 350,000 pounds to spend on yourself tax free. In other words, you are in a similar position to what you would be had you sold the house but you’ve avoided all taxes.
              In a system in which capital gains taxes are set at ordinary income rates, you will not only be taxing totally losses that look like profits because of inflation, but you will push people to avoid paying capital gains taxes by simple expedients like that described above (and there are many, many more).
              The article is absolutely correct about capital gains taxes. If you want to maximize your revenue take you need to keep them as low as possible.

              • Russell

                You ignore the fact that I have had somewhere to live which has not cost me a penny in rent saving me a huge amount of cash (adjusted over the period for inflation)

                • FMarion

                  You are correct on that point. It is not as absolute as you indicate because you’ve had to deal with maintenance costs (including probably some big capital items) as well as taxes. My guess is that given that your savings have probably come to something like half of what a rental payment would have been.

                  Nevertheless, a house can indeed be a home and provides significant economic benefits that the tax system generally does not capture.

                  However, for other assets which are also subject to capital gains, such as a bond, share of stock or a commercial property, that of course, would not be the case.

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