Will Cameron, Osborne and co water down the proposed CGT hike?

The real issue is whether increasing CGT will actually have the desired effect.

Last Updated: 31 Aug 2010

The first big test for the new coalition Government looks like being its proposed changes to capital gains tax rules; Tory back-benchers are frothing at the mouth about the potential hike, which they say will unfairly hammer Middle England. The Government has already got the most important thing right, by promising to spare entrepreneurs – and since the move was a critical part of the coalition deal, as a way of funding a tax cut for lower-income families, it’s hard to see it backing down altogether. But whether or not you agree with the philosophical justification of raising CGT, the problem is that a higher rate might actually push receipts down...

Whispers from Whitehall suggest that the Government plans to bring CGT into line with income tax, as well as reducing the threshold at which it starts getting charged. The justification for this is partly practical: they need the money to pay for that income tax cut for low-earners. But it's also philosophical: the Lib Dems, particularly Vince Cable, have long argued that the current rules just encourage income shifting – so wealthy individuals with clever accountants can turn their ordinary income into capital gains, and pay less tax as a result.

The trouble is that it’s not just wealthy individuals who’ll suffer: it’s also small investors who buy shares, or second homes as investment properties to fund their retirement. Since this group presumably includes lots of Tory voters, it’s no wonder backbenchers are up in arms. The Government has - quite rightly - already promised to make an exception for entrepreneurs who sell their stake in their business, on the grounds that it’s important to incentivise this kind of behaviour. On the other hand, the Government presumably also wants to incentivise us to invest and save rather than keep spending willy-nilly – yet a blanket hike to CGT would seem to have the opposite effect.

In a letter to the Treasury today, the slightly scary but undeniably big-brained MP John Redwood (aka Mr Spock) argues for a version of the previous taper relief scheme – so capital gains is taxed like income in year one, thus deterring short-term speculators and spivs, but tapers down with each passing year to encourage long-term investors (all the way to zero after five years, he suggests). We suspect a lot of people will see this as both fair and sensible.

The other issue, as Redwood points out, is that raising CGT might not have the desired effect of raising more money; in fact, studies have shown that in the US, for example, hiking the rate has actually reduced the tax take (and vice-versa). That’s because people make/ declare fewer gains, and the wealthy make sure any gains disappear entirely somewhere off-shore. So if the Government’s goal is to fund a tax cut, this isn’t necessarily the best way of doing it. We wouldn’t be surprised if the Chancellor is working on a watered-down version even as we speak.

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