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Capital gains tax

Capital gains tax. Stuart Adam Institute for Fiscal Studies. Outline. How capital gains tax has been reformed Evaluating the reform Simplicity Neutrality Encouraging investment and entrepreneurship. Capital gains tax in 2007-08. £4.8bn raised from 260,000 individuals (and trusts)

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Capital gains tax

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  1. Capital gains tax Stuart Adam Institute for Fiscal Studies

  2. Outline • How capital gains tax has been reformed • Evaluating the reform • Simplicity • Neutrality • Encouraging investment and entrepreneurship

  3. Capital gains tax in 2007-08 • £4.8bn raised from 260,000 individuals (and trusts) • Charged on asset’s sale price minus purchase price • Taxable gains in effect subject to income tax. But… • Several major exemptions: • Main homes, pension funds, ISAs, etc. • Any gains unrealised at death • First £9,200 per year • Taper relief reduces chargeable gain the longer the asset is held

  4. CGT taper reliefEffective tax rate for higher rate taxpayer

  5. Timeline of reform • 9 October: PBR announcement of flat 18% rate • No consultation • 6 months for asset holders to ‘arrange their affairs’ • Strong backlash from business lobby • 31 October: press reports possible concessions • 27 November: amendments “in the next 3 weeks” • 13 December: amendments “in the New Year” • 24 January: announced new entrepreneurs’ relief • 6 April: 18% rate and entrepreneur’s relief come into effect • A model of how not to undertake tax reform • Taper relief joins a long list of Labour tax reforms abandoned

  6. The reform • Taper relief abolished • All gains (above exempt amount) taxed at 18% • Except for entrepreneurs’ relief… • First £1m of lifetime gains (after 6 April 2008) on certain eligible assets taxed at 10% • 80,000 people forecast to be eligible in 2008-09 • Raises £700m per year

  7. Privileged assets Assets eligible for entrepreneurs’ relief: • Unincorporated business, or assets after stop business • Shares if shareholder has >5% and is employee Business asset taper relief was also available for: • Assets of continuing unincorporated business • Employees owning <5% • Non-employees owning >5%

  8. Main winners and losers Winners: • Higher-rate taxpayers with non-business assets • primarily second homes and most quoted shares Losers: • ‘Business assets’ not qualifying for entrepreneurs’ relief • Those realising total gains >£1m after 6 April 2008 • Some basic rate taxpayers • Some holders of assets from before 1998

  9. Simplification • CGT is notoriously complicated • Flat 18% rate looked extremely simple • Entrepreneurs’ relief much less so • Reintroduces distinctions between asset types • New record-keeping requirements

  10. When to sell assets • Shouldn’t distort decisions when to buy and sell • Tapering favours long-term holding of assets (NOT long-term investment) • Entreprepreneurs’ relief distorts in less obvious ways

  11. Which assets to hold • Shouldn’t distort choice of where to put money • Both taper relief and entrepreneurs’ relief do: • favour businesses over other assets • favour own business over someone else’s • favour non-corporate sector over corporate • The last of these could be solved by reduced rates on shares

  12. Form of remuneration • Should align tax rates on capital gains, dividends and salary • Differentials create avoidance, distortion and unfairness • Clear improvements available: • Reduced CGT rates on corporate equity • Basic and higher rates of CGT

  13. Encouraging investment • Higher rates of CGT discourage avoidance • But higher rates of CGT deter investment • Fortunately, there are better ways to encourage investment (eg capital allowances) • Indexation for inflation is important • Even low inflation means a high tax rate on the real return • But indexation does entail some complexity • And argument less clear when inflation ignored for capital income taxes

  14. Encouraging entrepreneurship • Difficulty and risk do not justify tax breaks • Market failure might • But CGT looks particularly badly targeted • And little evidence that CGT is what stops people going into business

  15. Conclusions • Guiding principles should be simplicity and neutrality • Low CGT rates not the best way to encourage investment and entrepreneurship • Taper relief was a leap in the wrong direction • Flat 18% rate was a step in the right direction • Entrepreneurs’ relief is a shuffle back in the wrong direction • Much room for improvement • Align rates with those on earnings and dividends • Lower rates on shares to reflect corporation tax already paid • Consider reintroducing indexation for inflation • The process of reform has been shambolic • No consultation, lots of uncertainty, and a rush to sell assets

  16. Capital gains tax Stuart Adam Institute for Fiscal Studies

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