The Debate Over Capital Gains Tax Rates
Recent discussions have highlighted the potential for capital gains tax (CGT) rates to be increased significantly, aligning them more closely with income tax rates. This has sparked a debate about whether such a move would be beneficial or detrimental to the economy and individual taxpayers.
Key Figures and Proposals
Louise Haigh MP, an adviser to Andy Burnham, has called for a review of CGT rates in her article titled "Rebuilding the UK tax system" for the journal Renewal. She suggests that CGT rates should be brought closer to income tax rates. Similarly, Wes Streeting, a Labour MP, has advocated for aligning CGT and income tax, describing it as a "wealth tax that works" capable of raising £12 billion annually.
Mr. Streeting argues that the current system is unfair, penalizing work and harming the economy. He emphasizes the need for a wealth tax that works, stating that profits from owning assets should not be taxed less than income from work.
Current Tax Rates and Recent Changes
Currently, income tax rates are set at 20%, 40%, and 45%. In contrast, CGT rates are 18% for basic rate taxpayers and 24% for higher rate taxpayers. These rates were increased by Rachel Reeves in her October 2024 Budget, raising them from 10% and 20% respectively. Prior to this, former chancellor Sir Jeremy Hunt had reduced the annual CGT-free allowance from £12,300 to £3,000.
This discrepancy between income and CGT rates has long been a point of contention for those advocating for more taxes on wealth. Think-tanks like the Institute for Public Policy Research and the Resolution Foundation argue that investment and property profits should be taxed at the same level as income.
Arguments For and Against Raising CGT
Supporters of raising CGT argue that it would create a fairer system where income from employment and profits from investments are treated equally. It could also prevent business owners and executives from taking income via company shares to benefit from lower tax rates.
However, critics argue that such a move does not account for the risks associated with investment and entrepreneurship. There is also a strong argument for reintroducing inflation indexation alongside any CGT increase. This would mean only gains above inflation are taxed, ensuring genuine investment returns are not unduly penalized.
Ms. Haigh suggested in her Renewal article that aligning CGT rates should be accompanied by measures like inflation indexation. The Resolution Foundation echoed this sentiment, urging Labour to reset its economic policy and call for CGT rates to rise towards dividend and income tax levels, while introducing inflation indexation to reduce the disincentive to invest.
Potential Impact on Revenue
Investment platform IG has analyzed the potential impact of equalizing CGT with income tax rates. Their analysis using HMRC's methodology suggests that taxpayer behavioral responses could reduce Treasury revenues by approximately £7.8 billion annually.
Michael Healy, managing director of UK & Ireland at IG, warns that increasing CGT rates could discourage investment, especially given the UK's already low levels of retail investment among major developed economies. He emphasizes the importance of encouraging participation in the investment market rather than discouraging it.
Strategies to Protect Against a CGT Hike
Investors who have made substantial profits on shares or property could consider crystallising some gains by selling up or giving assets away. Unused portions of the current tax year's £3,000 CGT-free allowance can be used, with current CGT rates applied above that threshold.
Tax experts advise that decisions to sell for tax purposes should be carefully considered, with professional advice sought. They also caution against acting based on speculation. If indexation is reintroduced, some long-term investors could benefit despite CGT rates rising.
Married couples and civil partners can pass assets to each other free of CGT, allowing them to use both their tax-free allowances. This can be particularly beneficial if one partner pays a lower tax rate.
Using Tax-Friendly Shelters
It is always advisable to shelter as much of your investments as possible from CGT, especially with the annual tax-free allowance now set at just £3,000. Long-term investors and those with substantial holdings in company share schemes can often avoid large CGT bills by shifting assets into an Isa or pension.
The recent focus on CGT highlights the importance of using the tax-friendly shelter of a stocks and shares Isa wherever possible. Profits and dividends within an Isa are tax-free. CGT rules prevent investors from selling shares to crystallize a gain and then buying the same stock back within 30 days.
However, there is an exemption that allows assets to be sold and bought back immediately with an Isa. This is known as a Bed and Isa, and most investment platforms will carry out this process for customers.
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