Why are rich people reportedly selling assets to avoid potential Labour changes to capital gains tax?

Whoever wins the next general election will face extremely tough choices on taxation and spending.

As the independent Institute of Fiscal Studies has pointed out, both Labour and the Conservatives have ruled out changes to the big four revenue-raisers, income tax, national insurance, VAT and corporation tax.

And, while both parties have made relatively modest spending commitments, there seems little doubt that revenue from other sources will be required given the current spending plans already pencilled in from 2025 – which have been described by the Institute for Government as “implausibly tight”.

How could a new government raise funds?

Assuming both parties stick to the existing fiscal rules and choose not to raise borrowing – although that is certainly a possibility – it is therefore worth pondering what revenue-raising measures could be on the cards.

Labour has already confirmed it plans a handful of revenue-raising measures – most notably hiking taxes on North Sea oil and gas producers and slapping VAT on school fees – but these are very small in the overall context of total government spending.

That has led to intense speculation over what other levers Rachel Reeves might pull were she, as expected, to become Chancellor of the Exchequer.

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Much of that speculation has centred on capital gains tax (CGT), the tax levied on the profit made on the sale of an asset that has risen in value, not least because Labour has not ruled out changes to it.

Rich people selling assets and mulling a UK departure

The Financial Times reports today that “some rich individuals are selling assets such as shares and property in preparation for an incoming Labour government that they fear will increase capital gains tax”, citing comments from wealth managers.

It highlights chief executives, entrepreneurs and buy-to-let landlords as among those selling and quotes one wealth manager as saying some wealthy individuals were considering leaving the UK in the event of a significant rise in CGT: “You could see a brain drain of people who are building businesses, creating jobs and have already paid significant amounts of tax in the UK.”

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How does CGT work?

CGT is currently levied on most personal possessions worth £6,000 or more, including second homes, most shares not held in an ISA and business assets. It can also in some cases be levied on an individual’s main home if, for example, the property has been let out or has been used in part for business purposes.

But the fact that CGT, which brought in £15bn to the Treasury last year and which is expected to raise £19.5bn this year, is levied at a lower rate than income tax makes it a tempting target for the Treasury.

Basic rate taxpayers currently pay 10% on capital gains or 18% on residential property and carried interest (a share of a fund’s profits to which a fund manager is entitled).

For higher and additional rate taxpayers – those paying income tax at 40p or 45p in the pound – that rises to 24% on gains from residential property, 28% on gains from carried interest and 20% on gains from other chargeable assets.

A tempting target for Labour

Those lower rates mean there are serious savings to be made for people who choose to disguise their income as a capital gain.

Labour’s manifesto explicitly singles out one area where it will change the CGT regime – which is for managers working in the private equity industry.

It says: “Private equity is the only industry where performance-related pay is treated as capital gains. Labour will close this loophole.”

The manifesto claims this measure would raise £565m per year for the Treasury.

There are other reasons why an incoming chancellor might be tempted to target CGT.

How Labour could make CGT changes

The International Monetary Fund recently recommended expanding the scope of CGT although it would be a brave chancellor who removed the biggest exemption to CGT – gains on the sale of a primary residence – even though such a measure would bring in £25bn annually.

The most obvious lever to pull would be to bring the rates at which CGT is levied into line with the rates at which income tax is levied – something Ms Reeves herself called for in a pamphlet published in 2018.

This could raise between £8-£16bn for the Treasury – estimates vary – and was actually done by one of the UK’s greatest reforming chancellors, Nigel Lawson, in his Budget of March 1988.

The measure brought in considerable sums and the arrangement remained in place until 2007, when Alistair Darling reintroduced a new flat rate of CGT at 18%, way below the prevailing rates at which income tax was levied at the time.

There are good arguments for and against equalising the rates of CGT and income tax.

The case for and against equalising CGT and income tax

The main one in favour is fairness. Those who support raising CGT argue it is wrong for someone who makes a profit from selling land, buildings, shares or works of art to be taxed more lightly on that activity than someone who works for a living.

The chief argument against is that it punishes wealth creators – the entrepreneurs who take huge risks in setting up a business and employing people. They should, it is argued, be rewarded for their efforts and risk-taking.

Another is that CGT – which was introduced by Labour’s Jim Callaghan back in 1965 – has always been set below income tax because part of any capital gain is inevitably going to be due to inflation.

Various chancellors have sought to address this: Sir Geoffrey Howe introduced an indexation allowance in 1982 with the aim of ensuring individuals were taxed only on their ‘real’ capital gain rather than the element of it which was due to inflation.

Then, in 1998, Gordon Brown replaced indexation with ‘taper relief’ which ensured that, the longer an asset had been held, the lower the amount of CGT levied when it was sold. The aim of this was to distinguish between short-term speculators and entrepreneurs who had built up a business asset over many years.

Possible risks

Raising the rate of CGT might also lead to a drop in the tax take.

The vast majority of CGT, nearly three-quarters of the total, is currently raised from taxing the sale of business assets. And CGT is easily avoided by not selling an asset.

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A wealthy individual could do this, for example, by holding an asset until they die (CGT is currently not chargeable on death) and, should they choose to raise capital from it during their lifetime, by borrowing against the asset.

And, arguably, equalising CGT and income tax would not work today.

That is because – unlike in Nigel Lawson’s day – the top rate of income tax is now 45p in the pound.

Hiking CGT to this level would immediately make the UK’s CGT rate the highest in Europe. It could also risk a brain drain.

The UK is already alarmingly dependent on a very small number of taxpayers: the investment platform Wealth Club reported today, following a freedom of information request, that just 100,000 taxpayers – who represent just 0.3% of all UK taxpayers – pay a quarter of all income tax and CGT.

Many of those people are highly mobile and are not in the UK for the weather.

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Driving them abroad is not something a chancellor seeking to encourage entrepreneurs and investment to boost growth would want.

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