Capital Gains Tax Needs Serious Reform, Not Just More Tweaks

10th January 2025

As government finances deteriorate as shown by the borrowing issues that surfaced this week in the bond market. Added to the problems is the falling value of the pound so Capital Gains Tax is being more and more discussed as one way to fill the gap.

There are still ways to help and and taxes may be one way even though the government has ruled out changes to taxes affecting working people.

One such change was recently looked at by the Institute for fiscal Studies. Many people have said that Capital Gains Tax should be equalised with Income tax rates as people who recieve money by Capital Gains tax have an unfair advantage with lower rates.

So lets dive in to look at the IFS suggestions published on 12 December 2024 -

Capital gains tax needs serious reform, not just more tweaks

Should the government raise capital gains tax in the Budget? What is the case for reforming capital gains tax? What are the options for reform?

There is much speculation that the new government is considering increasing rates of capital gains tax (CGT) as a way of raising revenue. But simply raising rates is not the right route to take. The whole design of CGT is flawed. There are steps the government could and should take to make the tax fairer and less harmful to economic growth and well-being.

The case and options for reforming CGT are set out in new research, coauthored by researchers at IFS and CenTax and published today as part of the IFS Green Budget, funded by the Nuffield Foundation and produced in association with Citi. The report's key findings include:

CGT raises a growing amount of revenue, about £15 billion last year, partly reflecting the increasing role of wealth accumulation in the UK economy. That is still less than 2% of total tax revenue.
CGT is paid by around 350,000 people each year (0.65% of the adult population). Two-thirds of CGT revenue comes from just 12,000 people (0.02% of the adult population) who have average gains of £4 million.

CGT rates vary significantly across assets and are (almost always) significantly lower than tax rates on income. These rate differences are unfair and create undesirable distortions, including to what people invest in and how they choose to work.

The design of the tax base reduces UK productivity and growth by discouraging saving, investment and risk-taking and leading to a misallocation of capital away from its most productive use. For example, because there are not full deductions for the amounts of money that people invest, there are some investments that are commercially viable before tax but that are deterred by CGT.

Unaddressed, these problems would be significantly worse at higher tax rates. But keeping CGT rates low cannot solve the problems. In contrast, a well-designed tax base would greatly reduce - and in many cases largely remove - these problems. This would involve giving full deductions for any amounts of money saved or invested and more flexible treatment of losses.

Uplift (or ‘forgiveness') of CGT at death should be ended. It creates a very big incentive for people to hold on to assets well past the point at which it is efficient for them to do so. It is also clearly unfair.
With a reformed tax base, tax rates should ultimately be aligned across all forms of gains and income. This would involve significant increases to CGT rates.

Around half of taxable capital gains derive from private businesses. But business asset disposal (BAD) relief - a preferential CGT rate for business owner-managers - is not well targeted at entrepreneurship and creates a range of undesirable distortions. Removing BAD relief while giving more generous deductions for investment costs could boost investment while raising revenue from the top of the income distribution.

Higher CGT rates would increase the incentive for people to leave the UK before realising gains to avoid UK CGT. One option to address this would be to tax people emigrating from the UK on their accrued but unrealised gains, whilst exempting new arrivals from UK CGT on gains they made whilst living abroad. This would raise practical challenges and the design issues would have to be carefully considered, but the approach is already operated by some other countries.

The effect of CGT reforms on revenue would hinge critically on the exact reform enacted and on transitional arrangements. If, for example, tax rates were raised but uplift at death remained in place and the tax base was unchanged, we would expect many people to hold on to assets until death to escape CGT and that there would be a long-run dampening of the revenue gain via reduced investment incentives. Estimates suggest that uplift at death and BAD relief each cost around £1½ billion per year. Removing either relief would mean that more revenue would be raised by an increase in headline CGT rates (because a rate increase would apply to a broader tax base and there would be fewer ways to avoid paying higher rates).

Giving full deductions for amounts saved or invested would cost revenue - but this could be more than offset by increasing rates so they are better aligned with the rates levied on income. The actual amounts that could be raised would depend on many factors and would be very uncertain.

Helen Miller, Deputy Director at the Institute for Fiscal Studies and an author of the report, said, "Capital gains tax is a small but important tax. Its design is flawed and this matters for both the efficiency and fairness of the tax system.

‘The new Chancellor should use her first Budget to create a capital gains tax that is fairer and more growth-friendly. The only way to do this is to reform the tax base alongside increasing tax rates. Getting the design of any reform right is crucial. But a sensibly reformed CGT would be a significant prize and should be a priority regardless of how much revenue she would like to raise overall. Good reform would also make it easier to raise significant additional revenue.

‘If the Chancellor chooses to raise CGT rates while leaving the flawed tax base unchanged, she would be choosing to raise some, limited, revenue at the expense of weakening saving and investment incentives and further distorting which assets people buy and how long they hold them for. That would not be the decision of a Chancellor who was serious about growth.'

Authors
Stuart Adam
Senior Economist

Stuart is a Senior Economist working in the Tax sector, and focuses on analysing the design of the tax and benefit system.

Arun Advani
Arun is a Research Fellow at IFS, an Associate Professor of Economics at the University of Warwick and a Commissioner at the Wealth Tax Commission.

Helen Miller
Helen is Deputy Director of the IFS and Head of the Tax sector.

Andy Summers
Andy Summers is an Associate Professor of Law at the London School of Economics and an Associate of the International Inequalities Institute at LSE.

Source - https://ifs.org.uk/news/capital-gains-tax-needs-serious-reform-not-just-more-tweaks