Although the government has ruled out raising Capital Gains Tax in the upcoming budget, Labour’s broader tax and spending policies remain economically damaging, uncompetitive, and fundamentally misguided, says Daniel Herring
The government needs to find money for the upcoming Budget. Having ruled out the least damaging and broadest-based tax rises, Labour needs to resort to little taxes here and there to find money. Raising capital gains tax (CGT), even aligning it with income tax, was seen as a way that raised revenue while avoiding hurting working people. There’s support for this Cabinet: Wes Streeting called CGT a “wealth tax that works”. Louise Haigh is another prominent advocate. It is superficially appealing: why should different forms of income be treated differently?
However, CGT is a damaging tax and raising it is likely to be counterproductive. Thankfully the government has ruled out raising capital gains tax in the upcoming budget.
CGT is paid by a small number of people: 32,000 taxpayers account for 80 per cent of CGT revenue, and 5,000 account for half. Furthermore, people choose when to sell their assets. If they choose to hold an asset that would be better used by someone else in the economy (or sell prematurely ahead of a rise), that asset could be used less productively than if it had been owned by someone else. There is evidence of people moving the sale of assets to avoid paying CGT.
For these reasons, raising CGT could even lose money while being economically damaging. HMRC estimates that raising the higher rate of CGT by 10 points could lower revenue by £3.6bn after three years.
It also makes the UK uncompetitive. On Monday the Tax Foundation published the International Tax Competitiveness Index, which looks at how pro-growth tax systems are in the OECD. The UK comes 30th out of 38. Currently our highest CGT rate is 24 per cent, which is roughly in the middle of OECD countries. But in analysis I’ve done at the Centre for Policy Studies, raising it to 45 per cent would make the UK’s rate the highest in the world, and would make the lower UK’s overall tax competitiveness rank to 32nd.
The most respectable argument is that we should align CGT with income tax while introducing a generous allowance that allows for inflation (some call for an allowance even higher than inflation, called the normal rate of return, but leave that to one side).
Taxing entrepreneurship
There are good arguments to be made for this, but I still have concerns. In practice what this would mean is that most people paying CGT on very modest nominal gains today would pay no CGT, while a much smaller group who have extraordinary gains would have to pay more. This group would include our most innovative entrepreneurs – you want to be very careful about increasing taxes on this group.
But back to Labour. John Healey is walking a tightrope between markets and backbenchers. His backbenchers largely want to see increased spending, while business and markets want to see spending constraint and pro-growth reforms. In this case, he’s leaned towards listening to the likes of Jim O’Neill, who has said that raising CGT would send “the wrong message to business”.
Does this decision make John Healey a pro-growth Chancellor? I don’t think so. Ultimately, if growth was this government’s number one priority it would be finding ways to reduce taxes on business by cutting spending. There are other damaging taxes he will introduce, including a tax on banks. These are likely to raise little revenue and raise the cost of capital. These taxes come on top of already damaging tax rises made by Rachel Reeves, most notably the increase in employer national insurance.
Besides not really prioritising growth, all of this points to another fundamental misunderstanding within Labour. All countries that have higher spending governments raise most of their revenue through higher taxes on ordinary workers. You can either have a high spending state with high taxes on ordinary workers. Or you can have a low spending state with low taxes on ordinary people. Labour needs to choose which kind of state it wants. You cannot fund a high spending state while trying to squeeze only the rich. There aren’t enough of them and they’ll all leave.
Daniel Herring is head of economic and fiscal policy at the Centre for Policy Studies