Why Reeves is tempted by a brutal tax raid on capital gains

Chancellor’s bid to plug the Treasury’s £22bn shortfall threatens to have far-reaching consequences

He might be dismissed by opponents as the austerity chancellor who inflicted suffering on Britain’s working class. But George Osborne once sang from a very different hymn sheet.
“Some of the richest people in this country have been able to pay less tax than the people who clean for them,” he said in 2010.
Mr Osborne was hitting out at the allegedly unfair differences between taxes on work and investments as he launched a tax raid on capital gains to plug gaping holes in the public purse.
Six years later he slashed these taxes again, suggesting the move had been more about restoring finances than fairness.
Another chancellor with her back against the wall is now considering taking a leaf out of Osborne’s book – and she could go even further.
Capital gains tax (CGT) is an obvious candidate for hikes, says Stuart Adam at the Institute for Fiscal Studies (IFS).
“The Labour manifesto rules out quite a lot although exactly what it rules out rather depends on how you interpret the wording of it.
“If you look at what is left, capital gains tax is one of those. There is lots of speculation it might be where the Chancellor looks to. That strikes me as plausible,” he says.
Rachel Reeves has set the stage for tax rises at her first fiscal event in October – and speculation is growing that she will target CGT, potentially even equalising it with income tax where higher earners pay 40pc or 45pc – an eye-watering increase from the current typical 20pc rate.
There is a shortfall of £22bn in 2024-25 alone, partly to cover public pay increases amid a recruitment crisis.
Reeves has refused to explicitly rule out raising CGT.
When pressed on the matter by Bloomberg TV on Monday she would only say it was “always important” to strike “the right balance” with tax policy.
While Reeves will likely only reveal which taxes she will raise in October, advisers say that Britain’s wealthiest have seen the writing on the wall.
“There is definite concern. Everybody knows that there is a big black hole in the finances, and those funds have got to be raised from somewhere without breaking a promise,” says Harry Bell, director of financial planning at wealth manager Charles Stanley.
Taxes on capital gains raised £14.8bn in the tax year ending in March, according to the Office for Budget Responsibility. 
This is small fry compared with income tax at £277bn, National Insurance at £180bn and VAT at £170bn. Reeves has ruled out any headline changes to these.
Nervous entrepreneurs and other wealthy people have been hitting the phones to size up their options, wealth advisers say. Some are already taking drastic measures.
“I have got clients who are leaving the UK in order to trigger capital gains taxes at current levels of 20pc on the basis that they feel that the UK has become more hostile towards wealth creators,” says Ceri Volkes, a partner who heads the private client and tax team in Europe at high-end law firm Withers.
Calls from Britons who are concerned about a tax grab have ramped up since the election, and particularly after Reeves announced the £22bn black hole, according to Volkes.
The uncertainty is prompting many to take action sooner rather than later.
“We’ve seen some clients selling a business who want the sale to go through ASAP at current capital gains tax rates. Accelerating, deferring and leaving – those are the main things that people are talking about at the moment,” Volkes says.
Some clients prefer to “sit on their hands” and “wait it out for a time when the rates come back down again”, she adds.
Julia Cox, partner in the private client team at Charles Russell Speechlys, is witnessing similar moves.
“Some people are actually talking about going non-resident to realise their gains. That is quite dramatic, not least because you have to go non-resident for effectively six years,” she says.
Others are trying to find complex ways to pay taxes on the gains at current rates while retaining the asset, she says.
“​​We have got clients who were thinking of selling shares, quoted or private, to their personal company or trust,” she adds.
A higher-rate taxpayer currently pays 20pc when selling assets like shares or 24pc when selling a second home or buy-to-let property.
In contrast, they would pay 40pc on any income earned from a regular job between £50,271 to £125,140, rising thereafter to 45pc.
Senior figures in the Labour Party like Angela Rayner have in the past spoken in favour of taxing capital gains more similarly to income.
However, many people are sceptical about such an increase over fears that it would limit investment and Britain’s ability to retain and attract successful risk-takers.
“There are very good reasons why capital gains tax is lower than income tax. If you look across Europe and other countries that is also typically the case,” Bell says.
“A lot of the capital gains tax that’s paid tends to come through business transactions, like business sales. That might be where business owners have taken much lower salaries over a very long period of time.”
Adam from the IFS says there are certainly ways the Government could improve how capital gains are taxed while raising more money.
“There are some reliefs I think there is a very good case for getting rid of,” Adam says.
If someone buys an asset that appreciates significantly during their lifetime, they can for example pass it on to their heirs. The person inheriting it is then only liable for any price gains since they inherited it.
“That is a particularly silly and damaging feature of the system,” Adam says.
“I think there is something to be said for bringing rates of tax on capital gains more into alignment with income,” he says.
However, doing so without reforming the system would make matters worse, he warns.
“It would discourage saving, investment, risk-taking and entrepreneurship and have horrible lock-in effects – and it’s sensitive to inflation and all of this kind of thing,” Adam says.
In fact, the last time a chancellor chose to tax capital gains and income the same was under Conservative Nigel Lawson.  
But unlike the current system, taxpayers did not get taxed on any gains below the rate of inflation, Adam adds.
“The system that Lawson introduced that was in place from 1988 to 1998 is easily the best capital gains tax system we’ve had in the UK,” he says, adding that an even better version would be to tax only gains that outpace a risk-free interest rate such as on gilts.
Volkes at Withers is unconvinced this would be enough to allay her clients’ fears and keep them in the country.
“If you have clients in a sector that’s grown really fast – in technology or the AI space – those who have had really exponential growth – any kind of indexation for a business that was founded maybe three, four or five years ago just does not help them at all,” she says.
“Equalisation with income would be a deal breaker for those clients, and they would either look to leave the UK or to defer the [sale].”
Stephen Millard, deputy director of the National Institute of Economic and Social Research (Niesr), urges the Chancellor to resist the urge to raise capital gains tax.
“What you absolutely don’t want to do is increase capital taxes, I would very much argue against that,” he says, warning that the country needs more investment, not less.
“Unless the Budget really makes the case for capital spending, then it is not clear where growth is coming from,” adds Adrian Pabst from Niesr.
“Then you get trapped in low investment, low growth, flatlining productivity and wage growth that is going up but is still not spread around the country enough for people to feel better off.”
Faced with a big gaping hole in public finances, Reeves may ultimately still decide to follow in the footsteps of former Conservative chancellors.
Additional reporting by Tim Wallace