HOWARD FLIGHT: TIME TO CUT CGT
CGT is a damaging tax, and the current high top rate is likely to be undermining our economic recovery, reveals a new Centre for Policy Studies Pointmaker The case against CGT by Howard Flight and Oliver Latham.
Capital Gains Tax (CGT) is economically a bad tax:
- It discourages entrepreneurship, savings and investment and so reduces economic growth.
- It distorts capital markets by encouraging individuals to hold on to assets that would be better off under different ownership.
- It channels funds into tax-exempt assets rather than those with the highest return.
- The sheer number of exemptions introduced by governments of all stripes is a tacit admission that CGT is a bad tax.
Economic theory suggests that cuts in capital taxes (like CGT) are more effective at encouraging long-run growth than cuts in, for example, income taxes. The additional revenue resulting from this extra growth could fund as much as 70% of the cost of a cut. Even ignoring its impact on growth, the distortionary effects of CGT mean that cuts in CGT could be achieved without major budgetary implications. In fact, cuts may actually increase revenue.
Importantly, the paper shows that if the Treasury’s justification for a top rate of CGT at 28% was that this rate was ‘revenue maximising’, this will no longer be the case when the top rate of income tax will reduced to 45%. In fact, then the CGT will be ABOVE the revenue maximising rate, and completely self-defeating (see p12 and the Appendix for the explanation for this in detail).
As a result, the paper concludes:
- There is no excuse for the Treasury not to cut CGT immediately to about 25% (which is where the Treasury model would suggest it should now be to maximise revenue).
- Even further, it considers the Treasury’s assumptions too pessimistic. Returning to the flat rate 18% rate would cost between £300m and £900m under their pessimistic assumptions, but we feel this is a huge overestimate. Economically a rate below 20% is highly desirable.
- A deeper cut to 15% would clearly make economic sense but would require political determination. A rate of 0% for assets held over the long term would also be economically desirable.
- In addition, indexation of gains should be reintroduced at the earliest opportunity.
Howard Flight commented:
“When the 28% higher rate of Capital Gains Tax (CGT) was introduced by the Coalition in its emergency 2010 Budget, I felt uncomfortable. Would such an increase in rates really lead to a long-term increase in revenue for the Treasury (the only sensible justification for such a move)? Or would higher rates – and a new form of complexity – act as a tax on success and distort investments decisions and disposals so that revenues, over time, would be lower than otherwise expected – and the optimal allocation of resources damaged?
Having been a businessman for over 40 years, I instinctively felt that the latter was the case… An implication of the Treasury’s own analysis is that, once the 45p top rate of income tax comes into effect next year, the 28% rate will raise less revenue than a lower rate. This is a ridiculous situation, and one which should be addressed immediately. There is simply no excuse for the Chancellor not to cut CGT in the Autumn Statement. This paper provides overwhelming evidence from both the UK and overseas that higher rates of CGT are damaging to growth because of the damage it does to resource allocation and competitiveness; to entrepreneurship and to business efficiency.”
Tim Knox, Director of the CPS, commented:
“Cutting CGT rates aggressively would provide concrete evidence to the business world that this Government really is prepared to do all it can to support growth and entrepreneurialism. The cost of such a policy would be minimal while the benefits are considerable. This is not the time to dither.”