Will raising the rate of capital gains tax in the October Budget help the economy?

Rachel Reeves announced some time ago that the there was a “black hole” in the Public Finances of £22 billion. However, the Office for Public Responsibility, the Centre for Policy Studies and the Institute for Fiscal Studies have all highlighted the real picture is significantly worse. We should expect that this will track through to some tough political choices for the Government make in the forthcoming Budget.

Raising tax is in itself not difficult for any Government to do, however, in their manifesto Labour committed to not increasing the rates of the main taxes: income tax, national insurance, VAT and corporation tax which themselves make up the bulk of the present tax take. Crudely this means, if the Government stick to their manifesto pledge, this means they will be left with seeking more from business rates, council tax, capital gains tax, stamp duty, inheritance tax,  Alcohol Duty and fuel duty.

Focusing on, one of these: capital gains tax, there has been much speculation over whether on 30 October there will be a rate increase and a possible alignment with income tax rates. While it might appear this would increase revenue, without a structural change to the tax, it may well make capital investment less attractive across the board, meaning the anticipated increase does not arise.

It may also require a reintroduction of indexation allowance to ensure inflationary increases in asset values are not taxed unfairly. It should also be noted that in recent years, there has also been a significant reduction in the amount of annual exemption for individuals and trustees. Until recently (tax year 22/23) the annual exemption for an individual £12,000 per annum, it is now just £3,000 for tax year 24/25. This already makes realising capital gains in investments outside of ISA wrappers less attractive.

HMRC issued a bulletin in June this year “a ready reckoner” of the likely effect on tax take of raising tax rates in future years by varying amounts. HMRC’s figures indicate that raising the higher rate of capital gains tax by say 10% is likely to decrease the overall capital gains tax take significantly in the near future. This perhaps not surprising as  capital gains tax is a tax paid largely by those at the top of the wealth spectrum and such people often have a degree of flexibility  to enjoy their wealth as income or capital gains. They also have flexibility as to when to trigger capital gains and, faced with higher rates, may wait for tax rates to come down.  

HMRC also refer to the interaction between taxes. They note where the residential property rate of capital gains tax (currently 24%) increases this tends to lead to a decrease in SDLT revenues. Similarly an increase in the non-residential property rate of capital gains tax (currently 20%) can lead to an increase in income tax.

In a recent article by RSM it was noted that the reduction made by the last Government in the highest residential property capital gains tax rate of 28% to 24% in April 2024 has apparently increased capital gains tax take overall for the comparable period the year before - £854 million compared with the previous period of £778millon.

All this, of course, has to be looked at as part of a wider picture. It's perhaps not surprising that there have been a significant number of capital gains disposals in recent times with the prospect of the current Government’s likely changes and the rumours of increased capital gains tax rates.

For residential property, there are also a number of tax reforms on the horizon, such as the renters (reform) legislation giving tenants more security over let properties. For second homes the likelihood of  increases to council tax coupled with the proposed removal of most of the tax perks for those making their homes available for part of the year as furnished holiday accommodation are likely to be key drivers in disposals too.

RSM also highlight in their article that a significant proportion of the capital gains tax take has historically derived from a relatively small group of wealthy investors who have structured their wealth through funds to derive their profits as “carried interest” which are taxable to capital gains tax at 28%, rather than to income tax. The Resolution Foundation apparently sought details from HMRC on the makeup of the capital gains tax and it transpired for 2017/2018 the total capital gains tax take was £1.76 billion, but £580million of this was derived from the carried interest receipts of just 2,000 individuals - which is quite striking. The Government issued a consultation in July on possible reforms to the way in which carried interest is taxed in future. In an article just earlier this week, the IFS highlight the need for significant reform to the capital gains tax legislation. They point out that, last year, the capital gains tax receipts amounted to some £15 billion being just 2% of overall tax. This tax was paid by only 350,000 people (0.65% of the adult population) and two thirds of this total was paid by just 12,000 people (0.02% of the adult population).

The IFS are clear that simply raising capital gains tax rates is not itself helpful and what we need is a radical structural reform to make it a more “growth friendly” tax as well as to increase revenues. They advocate, for example, abolishing business assets disposal relief and instead giving more generous investment cost deductions to businesses. Another key change might be to remove the current “wash out” of capital gains on death. Currently, on the death of a spouse, the surviving spouse inherits the assets at an updated capital gains tax base value and with no Inheritance tax charge either. This encourages wealthy people to hold on to investments standing at large capital gains until after the first death, which they can then sell without a charge on the historic gain. Another idea put forward by the IFS would be to tax people on their accrued, but unrealised capital gains when they emigrate from the UK, but give generous tax treatments when people arrive.

We'll have to wait until 30 October to discover what is in the Budget. However, it seems like capital gains tax needs more than just a rate increase if the Government wish to promote a higher tax take and also promote growth.