Balancing Act: Exploring Labour’s Capital Gains Tax Strategy Amid Concerns of Wealth Flight

Capital Gains Tax: Understanding Its Role and Labour's Strategy to Boost Revenue Without Losing Wealthy Taxpayers

The disparity between capital gains tax and income tax rates makes this a viable option for Labour to increase government revenue. However, there are potential pitfalls in this approach, as Sky's Ian King explains.

Business host @iankingsky

Wednesday, July 3, 2024, 1:

The victor of the upcoming general election will be confronted with difficult decisions regarding tax policies and fiscal expenditures.

According to the independent Institute of Fiscal Studies, both the Labour Party and the Conservative Party have decided against altering the primary sources of revenue, which include income tax, national insurance, VAT, and corporation tax.

Both political groups have proposed fairly conservative fiscal plans, yet it appears inevitable that additional funding sources will be needed to meet the expenditure outlined for 2025 and beyond, which the Institute for Government has labeled as "highly unlikely" to be sufficient.

What methods might a newly established government use to generate revenue?

Considering that both groups adhere to the current financial regulations and opt not to increase debt—a scenario that remains plausible—it's important to contemplate potential strategies for generating additional revenue.

Labour has announced its intention to implement several measures aimed at increasing revenue, including raising taxes on North Sea oil and gas companies and applying VAT to private school tuition. However, these steps represent a minor portion of the total government expenditure.

This has given rise to widespread conjecture about the additional measures Rachel Reeves could implement if she were to be appointed as Chancellor of the Exchequer, as anticipated.

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A significant amount of the conjecture has focused on capital gains tax (CGT), which is the tax imposed on the profit from selling an asset that has increased in value, especially since the Labour Party has not dismissed potential modifications to this tax.

Wealthy individuals are considering offloading their assets and contemplating leaving the UK

According to today's Financial Times, numerous affluent people are offloading assets like stocks and real estate in anticipation of a potential Labour government, which they believe could raise capital gains taxes, as noted by statements from wealth advisors.

The article points out that key business leaders, property investors, and company founders are among those offloading assets, with one financial advisor noting that several affluent people are contemplating moving out of the UK if capital gains tax increases substantially: "There could be an exodus of talented and entrepreneurial individuals who have contributed to business development, job creation, and have already paid considerable taxes in the UK."

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What is the mechanism behind Capital Gains Tax

Capital Gains Tax (CGT) is applied to various personal assets valued over £6,000, such as additional properties, the majority of shares not included in an ISA, and business assets. This tax may also be imposed on a person's primary residence under certain conditions, such as if the property has been rented or partially used for business activities.

The reality that Capital Gains Tax (CGT) contributed £15 billion to the Treasury last year and is anticipated to bring in £19.5 billion this year, while being taxed at a rate lower than income tax, positions it as an attractive option for the Treasury to consider targeting.

Individuals paying taxes at the basic rate are subject to a 10% capital gains tax, or 18% for gains from residential properties and carried interest, which refers to the portion of investment profits that fund managers receive.

For taxpayers who are subject to the higher and additional rates – those who pay 40% or 45% in income tax – the rate increases to 24% on gains from residential properties, 28% on gains from carried interest, and 20% on gains from other taxable assets.

An appealing objective for the Labour Party

Reduced rates present significant financial advantages for individuals who opt to classify their earnings as capital gains.

Labour's platform specifically targets a modification in the Capital Gains Tax policy, focusing on managers in the private equity sector.

The statement notes: "The private equity sector uniquely classifies performance-related compensation as capital gains. The Labour Party intends to eliminate this loophole."

The manifesto suggests that this policy could generate £565 million annually for the government's coffers.

Various factors could motivate a new chancellor to consider changes to Capital Gains Tax (CGT).

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Exploring Potential Adjustments to Capital Gains Tax

The International Monetary Fund has suggested broadening the range of Capital Gains Tax, but it would take a courageous finance minister to eliminate the most significant CGT exemption — profits from selling one’s main home — even though this could generate £25 billion each year.

The clearest action to take would be to align the rates of Capital Gains Tax (CGT) with those of income tax, a change that Ms. Reeves advocated for in a 2018 pamphlet she authored.

This initiative could generate approximately £8 billion to £16 billion for the Treasury, though projections differ. It was previously implemented by one of Britain's most transformative chancellors, Nigel Lawson, during his March 1988 budget announcement.

The policy generated significant revenue and stayed effective until 2007, when Alistair Darling implemented a new uniform CGT rate of 18%, significantly lower than the income tax rates at that period.

There are valid points to be made both in support of and in opposition to aligning capital gains tax rates with those of income tax.

Debating the Alignment of Capital Gains Tax and Income Tax Rates

The primary argument for it centers on equity. Proponents of increasing capital gains tax contend that it's unjust for individuals profiting from the sale of assets like land, buildings, stocks, or art to face lower tax rates compared to those earning through regular employment.

The primary objection is that it penalizes those who generate wealth—the innovators who venture into establishing businesses and creating jobs. The contention is that these individuals deserve recognition and rewards for their initiatives and the risks they undertake.

Another point is that Capital Gains Tax (CGT), established by Labour's Jim Callaghan in 1965, has traditionally been kept lower than income tax rates because a portion of the capital gains is naturally attributed to inflation.

Numerous finance ministers have tackled this issue: In 1982, Sir Geoffrey Howe implemented an indexation allowance designed to tax individuals solely on their actual capital gains, excluding any portion attributed to inflation.

In 1998, Chancellor Gordon Brown introduced a new system called 'taper relief' to replace indexation. This system reduced capital gains tax (CGT) on assets the longer they were held before being sold. The purpose was to differentiate between those quickly trading assets for profit and long-term entrepreneurs who developed their businesses over extended periods.

Potential hazards

Increasing the capital gains tax rate could potentially result in a decrease in overall tax revenue.

Approximately 75% of capital gains tax (CGT) revenue is derived from the taxation of business asset sales. Additionally, CGT can be simply evaded by choosing not to sell an asset.

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For instance, a person with significant wealth could avoid capital gains tax, which isn't applied at death, by retaining ownership of an asset until they pass away. If they need to access funds from the asset while still alive, they could opt to secure a loan against its value.

It could be said that aligning capital gains tax with income tax may not be effective in the current climate.

This is due to the fact that, unlike during the era of Nigel Lawson, the highest rate of income tax currently stands at 45 pence per pound.

Raising the Capital Gains Tax (CGT) to such a degree would position the UK as having the highest CGT rate across Europe. This could potentially lead to a talent exodus.

The UK's reliance on a small segment of its taxpayers is strikingly high, according to a report by Wealth Club. The investment firm found through a freedom of information request that a mere 0.3% of all taxpayers, totaling 100,000 individuals, contribute a quarter of all income tax and Capital Gains Tax collected.

Numerous individuals are extremely transient and don't come to the UK for its climate.

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A chancellor intent on attracting entrepreneurs and investment to stimulate economic expansion would not favor policies that drive them away.

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