Capital Gains Tax was born in 1965 at a flat 30%. Since then, every Chancellor who’s held the job long enough to redecorate the flat above Number 11 has had a go at it.
Geoffrey Howe bolted on indexation in 1982, so you only paid tax on real gains rather than the bit inflation had eaten. Nigel Lawson aligned CGT rates with income tax in 1988 — a clean idea that lasted exactly as long as Nigel Lawson did. Gordon Brown scrapped indexation in 1998 and introduced taper relief, which charged you less the longer you held an asset. Alistair Darling scrapped taper relief in 2008 and brought in entrepreneurs’ relief — a 10% rate on business assets — which George Osborne renamed, expanded, then trimmed. Rishi Sunak renamed it again, to Business Asset Disposal Relief, which is the name it goes by today. Jeremy Hunt cut the rate on second homes from 28% to 24%. Rachel Reeves raised the main rates in October.
That’s nine Chancellors and at least a dozen meaningful changes in sixty years. CGT is the tax equivalent of a kitchen no one is ever quite happy with, and every new occupant decides what it really needs is a different splashback.
The result, predictably, is a mess.
CGT raises about £15 billion a year — less than 2% of total tax revenue, despite the political heat it generates. It is paid by around 350,000 people, which is roughly 0.65% of the adult population. Two-thirds of the revenue comes from 12,000 people. Their average gain is £4 million.
So this is a tax paid by very few people, on a small number of very large transactions, and almost everyone making those transactions has spent a great deal of time and money working out how to pay as little of it as possible. Which, when the rules change every other Budget, is a perfectly rational thing to do.
Here is the awkward bit. The Institute for Fiscal Studies — which is not in the business of producing campaign material for either side — argues that the real problem with CGT isn’t the rate. It’s the design.
The rate is what everyone fights about. The design is what makes the tax inefficient.
Take just one example. If you hold an asset until you die, the capital gain is wiped out. Not deferred, not reduced — wiped. Your heirs inherit it at its current market value, and the years of accrued gain vanish into the air. It’s known as the “uplift on death,” which is the kind of name a tax policy gets when the people writing it would prefer you didn’t think about it too hard.
What this does, in practice, is create a powerful incentive to hold on to assets you’d otherwise sell. If you’re 75 and you own a portfolio that’s tripled in value, selling it triggers a CGT bill. Not selling it, and bequeathing it, doesn’t. So you hold. Capital that might be more productive elsewhere stays put, because moving it costs you 24%.
We meet prospective clients who have skewed their investment portfolio holding on to shares or funds to avoid paying it. Even worse we have seen people hold onto money to avoid paying CGT when all that is going to happen is their kids will pay 40% of the whole amount (not just 24% of the gain) in Inheritance Tax.
The IFS reckons the uplift on death costs the Exchequer roughly £1.6 billion a year. Business Asset Disposal Relief — the descendant of entrepreneurs’ relief, currently charging 18% on the first £1 million of gains when an owner-manager sells their business — costs around £1.5 billion. Both are defended on the basis that they encourage investment and entrepreneurship. The IFS, having looked at the actual data, finds little evidence that either does much of either. Owner-managers don’t invest more in their businesses because of BAD relief; they just hold more cash inside the company.
So we have a tax that raises a modest sum, is paid by a tiny number of people, distorts the behaviour of almost everyone caught by it, and is propped up by reliefs that don’t achieve what they were designed for. The intuitive response — put the rates up — is precisely the wrong place to start. Higher rates on a badly designed base make the distortions worse, not better. People hold assets even longer. More money flows through the reliefs. The tax becomes more avoidable, not less.
Fix the base first. Remove the uplift on death. Take a hard look at BAD relief. Allow proper relief for losses. Then, with the leaks plugged, rates can rise without doing the damage that current rises would do. The IFS goes further and argues that, ultimately, CGT rates should be aligned with income tax rates — because there is no good reason why the same pound, earned by the same person, should be taxed differently depending on whether HMRC chooses to call it income or a gain.
That last point is contentious and we can save it for another day. But the smaller point isn’t. If we are going to raise more from CGT — and the maths of the intro to this series suggest we are — we should at least raise it from a tax that works.
Otherwise, we’re just handing the next Chancellor a fresh splashback.
Altor Wealth advises clients from our office in Hook, across Hampshire, Surrey, Berkshire, Sussex and Kent, and throughout the UK using the latest technology.