Tackling Tax

An unjust tax system that favours the few only serves to hurt us all. Revelations of widespread tax avoidance unearthed in the Panama Papers has thrust the UK’s fiscal system to the forefront of public consciousness in an unprecedented fashion. The Labour Party must take this rarest of opportunities to hammer the Tories not just for their championing of tax havens, but for their pig-headed approach to taxation as a whole.

That’s why it’s pleasing to see Liz Kendall leading the charge against the government’s regressive capital gains tax (CGT) cut. This is the tax charged on the increase in value of assets when you sell them – typically stocks, bonds, and property – and has been a stalwart of our fiscal system since 1965. Right now, the basic rate of CGT for taxpayers paying the basic rate of income tax - those earning less than £43,000 a year - is 18%. For those earning more, it’s at 28%.

Yet in last month’s Budget, the Chancellor slashed the higher rate to 20%, and the basic rate to 10% as part of an ill-considered attempt to put “rocket boosters on the backs of enterprise and productive investment.”

A CGT cut will do neither. As the Institute for Fiscal Studies explains, targeted capital allowances aimed at specific sectors, like the small business sector, are more effective in boosting investment because they grant relief specifically on capital investment – the funds used to grow a business - rather than all kinds of investment, such as that done on a purely speculative basis.

As for championing enterprise, the government would do better to increase the flow of public funds to Local Enterprise Partnerships, the largely voluntary organisations set up to replace the more generously taxpayer-funded regional development agencies introduced under Labour. A PWC report from 2009 showed that these agencies added £4.50 in gross value added to each region for every £1 spent – an impressive return.

A considered approach to CGT must balance two competing objectives: minimising the scope for tax avoidance by aligning tax rates for capital with those for income, and maximising incentives for savings and investment.

If a taxpayer in the 40% income tax band can find a way to convert their income into a capital gain that is then taxed at just 20%, that creates an incentive for tax avoidance – hurting the Exchequer.

On the flipside, if a property owner doesn’t want to take a 28% CGT hit from selling a second home, they will be less likely to put it on the market where it can be bought by someone who values it more – like a first time home buyer.

Labour can achieve this balancing act in two ways. First, by harmonising CGT and income tax rates to remove the opportunity for arbitrage. This will mean wealthier taxpayers will both pay more and lose the incentive to stash their income in lightly taxed assets. 

Second, by making sure only real capital appreciation, and not the immaterial gains caused by inflation, are taxed. This can be achieved by restoring indexation allowances, which tailors the amount of capital gain subject to the tax using an inflation measure. So that house the property owner wants to sell will have a smaller taxable gain than it would under a flat rate without an indexation allowance

The resulting system would be simpler and fairer – something people across the country can get on board with. Let’s not waste another moment: let’s make an aggressive case for CGT reform, and let’s do it while the Tories’ gross incompetence is on full public display. 

Louie Woodall is a Young Fabians member

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