The debate surrounding the alignment of Capital Gains Tax (CGT) with income tax in the UK has gained significant attention in recent years. CGT is a tax imposed on the profit made from the sale of assets, such as stocks, real estate, or businesses.
Currently, CGT has its own set of tax rates and allowances, separate from income tax. Advocates argue that aligning CGT with income tax would create a fairer tax system and billions more for government public resources, while opponents raise concerns about potential economic consequences for businesses and households.
We examine the arguments on both sides and the potential economic implications of aligning CGT with income tax for both businesses and households…
What Is Capital Gains Tax (CGT)?
Capital Gains Tax (CGT) is a tax imposed on the profit or capital gain realised when an individual or entity sells or disposes of certain assets. This includes stocks, real estate, businesses, or valuable possessions. It is not levied on the total sale price but rather on the difference between the selling price and the original purchase price, commonly referred to as the “capital gain.”
CGT is typically applicable to UK residents where individuals and businesses are required to report and pay tax on their capital gains. In the 2023/24 tax year, CGT is charged at the rate of either 10% (gains from other chargeable assets) or 18% for basic rate taxpayers (gains from residential property). Similarly, for higher or additional rate taxpayers, the rate is either 20% (gains from other chargeable assets) or 28% (gains from residential property).
Back in 1988, the then Conservative Chancellor, Nigel Lawson (father of Nigella) set the rates of CGT at the same level as income tax. Since then, the rates have risen 16 times from below £5bn a year to an estimated £80bn in the financial year 2020-21. However, quite strikingly the amount of tax raised from capital gains has only risen threefold to approximately £15bn.
Arguments in Favour of Alignment
Equity and Fairness
One of the primary arguments in favour of aligning CGT with income tax is the principle of fairness. Proponents argue that it is inequitable for individuals to pay different tax rates on their income and capital gains. Currently, the highest income tax rate in the UK is 45%, while the highest CGT rate is 28%. Aligning these rates would ensure that individuals with similar earnings pay a consistent level of tax, irrespective of whether their income is derived from work or investments.
The combined effect of income tax and national insurance payments enables people in employment to pay much higher rates of tax than those who benefit from lower capital gains tax (CGT) rates on property and shares income. For example, a university graduate earning £35,000 a year will pay nearly double the average tax of a landlord with the same income from rent on property. Likewise, a person receiving £60,000 a year in the form of capital gains or dividends pays less tax than someone aged 16 to 64 in a job earning £35,000.
The UK tax system is often criticised for its complexity. Aligning CGT with income tax would simplify the tax code, making it easier for individuals and businesses to understand and comply with their tax obligations. This simplification could lead to cost savings for both taxpayers and the government.
Advocates argue that aligning CGT with income tax could lead to increased tax revenue for the government. Higher-income individuals often use various strategies to reduce their taxable income and shift it into the lower-taxed CGT category. By aligning the rates, the government could reduce tax avoidance opportunities and collect more revenue to fund public services.
According to the Office of Tax Simplification (OTS), putting CGT up to the level of income tax would raise £14bn in public resources.
Arguments Against Alignment
Negative Impact on Investment
One of the key concerns raised by opponents of aligning CGT with income tax is that it could discourage investment. Lower CGT rates have historically incentivized individuals and businesses to invest in assets such as stocks, real estate, and start-ups. Aligning CGT with income tax could result in higher tax liabilities on investment gains, potentially reducing the appetite for investment in the UK.
Impact on Entrepreneurship
Start-ups and small businesses often rely on the sale of assets to fund growth and expansion. Aligning CGT with income tax could impose a heavier tax burden on entrepreneurs who sell their businesses or assets to finance new ventures. This may stifle entrepreneurship and hinder economic growth.
Potential Economic Consequences
Critics argue that aligning CGT with income tax could have broader economic implications. By reducing the incentive for investment and entrepreneurship, it may slow down economic growth and job creation. Additionally, it could lead to capital flight as investors seek more tax-friendly jurisdictions.
What Are The Economic Implications Of Aligning CGT & Income Tax?
The economic implications of aligning CGT with income tax in the UK are complex and depend on various factors, including the specific tax rates chosen and the overall economic environment. However, some potential consequences include:
Impact on Investment
If higher CGT rates discourage investment, it could lead to a reduction in capital inflow and hinder economic growth. On the other hand, if the revenue generated from aligning CGT with income tax is used to fund productive investments, it may offset the negative effects.
Higher CGT rates may discourage entrepreneurs from taking risks and starting new businesses. This could have long-term implications for job creation and innovation in the UK, particularly at a time when economic uncertainty is already rife. Similarly, while aligning CGT with income tax may increase tax revenue in the short term, it could lead to reduced tax revenue in the long term if it dampens economic activity and investment.
Investors and individuals may change their behaviour in response to the tax changes. They may hold assets longer to delay realising gains or explore tax-efficient investment alternatives. This naturally stagnates economic growth.
The debate over whether CGT should be aligned with income tax in the UK is multifaceted, with valid arguments on both sides. While proponents emphasise fairness and simplification, opponents are concerned about the potential negative impact on investment, entrepreneurship, and the broader economy.
Ultimately, any decision to align CGT with income tax should consider the specific tax rates, exemptions, and transitional measures to mitigate unintended consequences. Balancing fairness with economic growth is a challenging task for policymakers and one that’s not going to go away anytime soon.
We hope this outlined to you the arguments and implications of aligning CGT with income tax. If you’d like to know any further information, or anything accounting-related, please do not hesitate to get in contact with us at Nordens, where one of our trusted advisors would be happy to talk you through your query.