Why Labour might be tempted to raise capital gains tax

Labour’s promise that it would not increase major taxes such as income tax, national insurance and value added tax has led to increased speculation around another prominent revenue raiser — namely capital gains tax.

The levy, which raised £16.9bn in 2022-23, is not as lucrative as the UK’s biggest taxes, but any significant reforms could draw fierce opposition from entrepreneurs and investors.

CGT is paid on the profit from the sale of assets ranging from shares and business assets to second homes. The highest rate of CGT is 28 per cent, far lower than the top rate of income tax which sits at 45 per cent.

Arun Advani, a tax expert at the University of Warwick, estimates that equalising CGT and income tax rates would raise £16.7bn a year, although that does not include the impact of potentially indexing gains for inflation.

One of the benefits of equalising CGT and income tax rates, he said, was to reduce the incentive for people to switch income into capital gains to reduce their tax liability.

Further CGT reforms to limit exemptions would raise around £1.5bn in the current tax year, Advani added. There is a discount rate charged on unlisted shares, known as investors’ relief, and relief on the sale of all or part of someone’s business.

“A reform that equalises rates would raise some much needed cash for public services, make the system fairer, and remove the incentives to ‘shift’ income into gains to get a tax break in ways that tend to be bad for growth,” he said.

CGT has come into the spotlight as Labour comes under pressure to show how it would fund its ambitions to improve public services at a time of severely constrained public finances.

Sir Keir Starmer, the Labour leader, told the Guardian on Monday that he could not rule out lifting capital gains tax if he becomes prime minister after the UK general election on July 4.

“I’m not going to write five years’ worth of budgets three and a half, four weeks before an election,” he said. “None of our plans require tax rises over and above the ones we’ve already set.”

The Lib Dems by contrast put a promise to raise CGT in their manifesto unveiled on Monday.

As things stand, CGT is levied at a variety of rates ranging from 10 per cent to 28 per cent depending on the asset class and the taxpayer’s income, while income tax rates range from 20 per cent to 45 per cent.

There is also an annual allowance of £3,000, which Tory chancellor Jeremy Hunt cut from £12,300 over the past two years.

Rachel Reeves, Labour shadow chancellor, in a 2018 pamphlet proposed that CGT could be paid at income tax rates with the annual allowance halved.

In September 2021, four months after becoming shadow chancellor, she said “people who get their income through wealth should have to pay more”. She later ruled out “a wealth tax”.

Taxing capital gains at a lower rate than income was intended to encourage risk-taking by entrepreneurs, said Edward Grant, a director at wealth adviser St James’s Place.

“We want people to invest, we want people to take risks. And if you make it difficult or discourage them, that will have a knock on effect on future growth for the UK economy,” he said.

Andrew Jeffs, partner at Cavendish who advises people on selling their businesses, warned that entrepreneurs could sell their companies if they felt the tax was too high.

Avoiding a fire sale of assets before an increase in the CGT rate could require a surprise announcement.

Tax Policy Associates, the think-tank run by former corporate tax lawyer Dan Neidle, said pre-announcing changes had proven to be a mistake in the past. In 1988, when then Tory chancellor Nigel Lawson raised CGT to align it with income tax, investors rushed to sell shares before the new rate kicked in.

Ian Cook, financial planner at Quilter Cheviot, said that clients were in a wait-and-see mode about potential capital gains tax increases. But he said that he did not anticipate increases leading to a higher tax take.

“In practice I could see revenue dropping as a result,” he said. “In some ways CGT is a voluntary tax, it’s a tax you pay because you decided to sell that asset. If the rates go up too high, you may decide not to sell that asset.”

The levy is ultimately paid by a tiny share of the UK population. Less than 3 per cent of UK adults paid capital gains tax over the decade up to 2020, a paper from the University of Warwick and London School of Economics showed in February.

More gains were received by residents in a part of Notting Hill in London than in Liverpool, Manchester and Newcastle combined, the research showed.