Capital gains tax hike was inevitable – but it must be done fairly
By
MoneyWeek editor-in-chief
Merryn Somerset Webb May 19, 2010
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We were pleased when Alistair Darling first cut the rate of capital gains tax from 40% to 18%. We liked the idea of having one low rate, and we really liked the way he just dumped the complications of indexation (under which the amount of CGT you paid was reduced relative to the inflation suffered during the time you had been holding your investment).
Not everyone was convinced at the time. Those who had been holding assets for the long term saw it not as a cut, just as a change in calculation methods: for them the fall to 18% merely compensated them for the extra gains taken into account by the tax man thanks to the loss of indexation.
Still, we loved the change for the way it made calculating and collecting the tax so simple, even if we were later irritated by the financial industry's efforts to reclassify income as capital gains in order to avoid income tax.
We even dreamed - just a little - of a future full of tax simplification. "If Darling can do it with CGT," we thought, "maybe someone can do it with income tax…"
So how do we feel about CGT going back up to 40%, as George Osborne says it will in his emergency budget?
Not too bad. Much as we would like to think that the UK's massive debt can be dealt with purely with spending cuts, we also know it isn't going to happen. And if taxes are to go up, capital gains tax was always going to be the obvious first choice – not least because Nick Clegg has long been maddened by the rate being flat, despite the widening financial inequality in the UK.
It also seems odd, as many have pointed out, that those making large capital gains on a regular basis can end up paying less tax than a minimum wage worker (although to be fair, on the flipside, most capital gains tax payers won't be receiving much in the way of tax credits and the like).
It makes sense that the rate should go up for buy-to-let investors too. The buy-to-let brigade may whine about it, but they are the ones who are constantly telling us that it isn't about capital gain but long-term yield. We'll see from the rush to sell just how true that is – not that anyone who bought at the peak of the mania for new build in 2006 and 2007 should have much in the way of capital gains to worry about.
I'm also fine with it going up for second home owners – we all know that a large part of the problem with the UK housing market is that the speculative element constantly trumps the utility element. Higher taxation might go some way to prevent that. It might also cut down on the number of empty homes in the UK. Depending on who you listen to, at least 850,000 properties and probably more are sitting vacant in the UK: encourage second home owners to sell and they may soon be filled with primary owners. Nothing too bad there.
We are also pleased to see that real business assets will be exempt.
And finally, we recognise that having capital gains rates divorced from income tax rates always results in endless efforts from the nation's tax specialists to find ways of making one into another – hence making what should be simple, very complicated indeed.
We hate to see any taxes going up and know that, given the way most people's pensions have been savaged over the last decade, the CGT rise isn't exactly going to be popular. But if a tax must go up, this is probably the right one to go for first.
Still, you can't just put up the rate and be done with it. Why? Because to do so would massively discriminate against long-term investors by taxing them not just on real gains, but on nominal gains (those due simply to inflation) too. When Nigel Lawson brought the rate up in line with income tax rates (25% and 40% at the time) back in the 1980s, he recognised the iniquity of this and did two things to stop it happening.
First he exempted all gains made before 1983. Then he applied first indexation and then taper relief to all gains. Inflation was much in people's minds in the early 1980s and is increasingly so again (as it should be given that annual RPI inflation has just hit 5.3%) so to get his tax rise through and to make it fair, Osborne is going to have to find a way to do something similar.
He could of course simply return to indexing – although this can be extremely complicated for those holding very long-term investments. But Lord Millet, writing in today's Times, has another idea. Why not just bring the starting point for paying tax forward again – say from 1982 to 1997 for now? "It would be a rough and ready solution to the problem of long-term inflationary gains, but it would at least be practical, avoid the need to value assets at a date nearly 30 years ago, and reward the long-term, not the short-term, investor." That seems to make some sense.
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Merryn Somerset Webb
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