Party Political Animal

Taxation of capital gains has been a muddle in the UK for decades. It relates to taxation of savings, which has been a major factor in our low levels of savings and high consumption.

CGT should not therefore be treated in isolation – it should be reviewed as part of a wider look at pensions and savings tax.

Some perspective. In the ’70s, capital gains was taxed at 30% compared to a top marginal rate as high as 98%. Needless to say, people capitalised income wherever possible – entrepreneurs would for example build up the value of their shares rather than taking large salaries. Even so, high inflation often meant people were taxed on non-existent real-terms gains.

The Conservatives after 1979 first allowed inflation indexing of gains – essential in an era of high inflation.  Then, when they reduced the top income tax rate to 40%, they equalised CGT at 40% to prevent distortions – the rate was a little high, but the system worked quite well and indexing, though complicated, at least meant that illusory gains were not taxed.

Enter new Labour’s bright, hopeful dawn in 1997. Nothing couldn’t be fixed – what works is best etc etc. Labour, having lost an ideology, were also a bit starry eyed about their new mates in the City who buzzed around the government honeypot, hoping for peerages – which many of them got – or rather bought.

So, CGT was cut to as little as 10% for entrepreneurs, but out went indexation – no bad thing in a lower inflation environment.

10% was, however, a little on the low side and contributed to a society where the very wealthy got filthy rich, and although the very poor got tax credits, everyone in-between was screwed by indirect tax rises, while the failure fully to raise the top-rate band dragged four times as  many people into top rate tax.

Then, of course, all hell broke loose, Labour were less dewy-eyed about their new rich best friends and we were left with a top rate of 50% and CGT at 18%, with obvious consequences.

But for the Lib-Cons now to rush into an ill-thought our equalisation would not be wise – many Tories, including Michael Forsyth, are correct in their warnings.

For a start, it could penalise people with long term assets whose gains have been eroded by inflation; but indexation is also complex.

And differential rates for people governments approve of or otherwise can be rough justice: higher second homes rates can clobber the not-so-wealthy elderly; lower rates for long-term investors can be distortive and end up helping the private equity spivs.

Factor in that for decades we have saved and invested too little and consumed too much and our economy is skewed towards housing and financial services.

Why? Because the pension system is so Byzantine that too many people are forced into the clutches of the financial services middlemen who rip them off for 2% a year, added to which they see their savings locked up until they are 55 or older. So people consume rather than save, or use their houses as tax shelters.

Most people area also not financially literate enough to run their own ISAa and get similarly ripped off – and if you take cash out, you can’t put it back tax-free – you lose that chunk of tax free savings.

Low savings and investment and high consumption plus an economy overweight in financial services and housing have been a major cause of long term economic weakness and contributed greatly to the recent crisis.

We need to recognise that our fiscal system has contributed to that by making savings difficult, bloating the property and fincial services sectors.

We need to tackle the problem as  a whole, not piecemeal. Here’s a start:

• Simplify pension rules and allow people to take a portion of pension savings tax free earlier in life if they need to – this will encourage and increase overall savings
• Allow people to use and reinvest ISA funds tax free if they need to – ie the tax-free pot available stays the same if you need access to funds and then put them back
• Educate people properly so they can make more of their own decisions without being ripped off by the financial services spivs
• Raise CGT by all means, but 50%, or even 40%, would damage investment – and without indexation would leave some people being taxed on losses
• Keep it simple with one rate and allow indexation for assets more than 10 years old – the complexity of indexation is balanced by the fairness
• And…have the same rate of CGT on house sales, but allow indexation and tax-free roll-over into new property – that would reduce the tax shelter and help to make our houses homes rather than financial instruments
• Take away all other tax reliefs on property, such as REITs

Just some thoughts.