Will reversing Capital Gains Tax cuts do more harm than good?

Jennifer Speedie

by Jennifer Speedie

Earlier this week, Jeremy Corbyn made a pledge to introduce 10,000 new police officers in England and Wales, the equivalent of one new police officer for every electoral ward. In a bid to finance the expansion in law enforcement, Labour has revealed plans to reverse cuts to Capital Gains Tax (CGT) that were implemented by the Conservative government in 2016. CGT is the tax on the profit that you make when you sell an asset that has increased in value, such as shares, funds, businesses and property (not including your main residence).  Between 2014-2015, CGT yielded £3.8 billion, raising more revenue than inheritance tax, a figure which rose to £5.5 billion between 2015-2016

The Government announced the cuts to CGT during their 2016 Budget, in a bid to ‘ensure that companies have the opportunity to access the capital they need to grow and create jobs’. From 6th April 2016, the higher rate of CGT was reduced from 28% to 20%, with the basic rate reduced from 18% to 10%. By cutting rates of CGT, the Government sought to create a ‘strong investment culture’ and provide ‘an incentive to invest in companies over property’. Labour has claimed that continuing with such cuts to CGT will cost the UK public services in excess of £2.7 billion over the next five years, and have pledged to reverse such changes to the tax as a means of funding new commitments.

However, will reversing cuts to CGT produce the revenue that Jeremy Corbyn is relying on? Arguments have been made that reducing rates of CGT actually encourage higher revenues for the Treasury. Matthew Lynn has argued that ‘if ever there was a clear example of a tax needing to be reduced to raise more revenue, then this is it’, and a report published by the Centre for Policy Studies argued that ‘cuts may actually increase revenue’. In 2010, the Government raised CGT rates, increasing the higher tax rate from 18% to 28%, only to see a loss in revenue. In 2008-09, prior to the increase in rates, CGT raised £7.85 billion, but this had fallen to £4.3 billion in 2011-12, £3.92 billion in 2012-13 and down to £3.90 billion in 2013-14.

CGT has been described as ‘economically a bad tax’, discouraging entrepreneurship, savings and investments and distorting capital markets. As a voluntary tax, the incentive of investors to refrain from selling their assets in order to avoid the considerable tax on capital gain remains high, often referred to as a “lock-in effect”. In his analysis, Lynn argued that when CGT rates stood at 18%, ‘people decided the tax was not too onerous’ and so obliged to pay it. However, once the rate increased to 28%, many people would prefer to reshuffle or hold onto their assets than pay such a large rate of tax.  High CGT increases the costs of capital investments, and therefore reduces the number of investments that occur, slowing wider economic growth. In their study into the effects of increases in CGT, the Adam Smith Institute concluded that ‘increases in capital gains taxes above a very modest level result in decreases in revenue’.

Jeremy Corbyn’s proposal to reverse cuts to CGT could end up doing more harm than good. As concluded by Lord Flight, ‘cuts in CGT would stimulate economic growth in both the short and the long run’. Reversing reductions in CGT rates would discourage investment and entrepreneurial risks, and would not necessarily equate to higher revenues for the Treasury, as people are more likely to hold back on selling their assets than if CGT was kept at a lower rate. High rates of CGT ‘depress economic activity and prevent the flow of capital to where it can be most productively used’, therefore reducing both economic growth and government revenue.

 

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