I’m an economist – this is what capital gains tax increase will mean for your money

This is Armchair Economics with Hamish McRae, a subscriber-only newsletter from The i Paper. If you’d like to get this direct to your inbox, every single week, you can sign up here. We’ll know very soon whether the new Chancellor, John Healey, will increase capital gains tax (CGT) in his forthcoming budget. It’s a hot topic. A string of left-leaning think tanks, including the IPPR and the Resolution Foundation, have urged him to do so. The Treasury is reported to have persuaded him to reject the most extreme version of the proposal, to increase taxation on capital gains, charged at the moment at 24 per cent for higher-rate taxpayers, to the same level as income tax, which goes up to 45 per cent and higher still in Scotland. But a lower increase might be on the cards. There are two dynamics here. One is how to get the most tax revenue in the medium term. The other is what a change in CGT would do to people’s behaviour. For example, would a cut in rate encourage more people to start their own businesses, and vice versa? They are linked, but it’s simpler to look at them separately. On the first issue, the Treasury calculates that the optimal rate for the tax is around its present levels. Former chancellor Rachel Reeves increased it from 18 per cent to 24 per cent for higher rate taxpayers in her first budget, with a lower rate going up from 10 per cent to 18 per cent. She also cut the annual exemption to £3,000. These changes do seem to have increased revenue, for receipts went up to a record £24.2bn in the 2024-25 tax year. But a lot of that was forestalling – a rush to sell assets in the months between the general election and her budget, for fear that she might put up the rates, as she duly did. We don’t know what will happen in the longer term, because CGT is a voluntary tax. You only pay it when you sell the asset, be it shares, a country cottage, a rental flat, whatever. If you don’t have to sell, it may be better to wait until the Government changes and market conditions improve. That leads to the other matter: to what extent do people change their behaviour not simply about the timing of a sale, but whether they buy the asset in the first place, whether they start a business, whether in an extreme case they move offshore to do so, and – hardest of all to judge – whether foreigners who are thinking of launching their business in the UK decide to set it up elsewhere. It’s really difficult to predict human behaviour with any precision, but the basics are clear. Being able to form a business and sell it at a profit is for many people a huge incentive. If higher CGT discourages them from doing so, the Government loses not only the CGT if and when it comes to be sold, but also corporation tax on its profits, income tax on the company’s employees, the VAT on its staff’s purchases, and so on. All we do know is that sometimes lower tax rates increase total revenue, the most extreme example being Ireland, which had a 12.5 per cent corporation tax, alongside other incentives. It is home to nine of the 10 top US technology companies, nine of the top 10 pharmaceuticals, and 14 of the top 15 medical technology corporations. As a result, foreign-owned multinationals provide 87 per cent of its corporation tax revenues, quite aside from all the tax from more than 600,000 employees. Faced with all this, maybe Healey won’t touch CGT, but what if he does increase them? There are two lines of approach. First, people who can do so should delay selling anything. If the Treasury is right and an increase cuts revenue, then he or his successor will be forced to change tack. A clever Opposition could commit to cutting tax were they to gain office, which would further cut revenue by giving people an excuse to hold off. Obviously, asset-holders shouldn’t be silly about this; if they do want to sell and are presented with a good offer, then tax should be a secondary consideration. The same logic applies to people seeking to start a business, for tax isn’t the only thing to consider. The second thing to do is to use the tax incentives that are on offer, notably ISAs and pension plans. Gains in both are free of tax on interest and dividends, as well as profits on sales that would otherwise incur capital gains tax. Over the years, this tax-free status makes a huge difference to the rate at which savings are likely to grow. UK Government bonds, gilts, are exempt from CGT, though it might not be a great time to buy them now. Buying gold sovereigns is another way of not paying the tax, because technically they are legal tender and therefore exempt – though again, maybe not the best time to buy. And the annual £3,000 exemption (£6,000 with a spouse or civil partner) is always worth taking. A final point. Governments need revenue, but they also need to create incentives. I would not be surprised if the Treasury thinks up some new ones to encourage savings and investment, to be trotted out in two weeks’ time. Need to know Beyond the mechanical impact of an increase in CGT is the effect it might have on asset values more generally, and in particular on the property market. If you think about shares, they are essentially an international asset, in that some 60 per cent of the FTSE 100 companies are owned abroad. Add in the UK holdings via ISAs and pensions and on my quick tally it’s about three-quarters. So any change in UK CGT won’t affect the market. But if you look at domestic property, it’s a quite different picture. There are some corners of the market that are principally owned offshore: ultra-luxury homes in central London, of course, and I suspect top-end properties in fashionable parts of the country such as the Cotswolds, too. But while the proportion of homes in England that are secondary residences is tiny, 0.6 per cent of the total, an increase in CGT could be a serious deterrent for would-be buyers. More sensible to put whatever money is available into the main house because any gains will be tax-free. Add this onto all the other tax increases, the higher council taxes, the mansion tax and so on, and the property market as a whole could take a serious hit. In one sense that’s good news: cheaper homes for first-time buyers. But if the present clouds over the upper end of the property market were to darken still further, we could have quite sharp falls in prices in money terms, alongside the current decline in real terms. Adjusted for inflation, house prices are down about 20 per cent from their 2021 peak. We have had sharp falls in property prices before, but ideally, you want these to be gradual. This leads to a final point. CGT applies to the money price of an asset, not the real price. So people may end up paying tax when they have made no gain after allowing for inflation, and may even have made a loss. At some stage capital gains will have to be indexed, but not, I’m afraid, by this lot.