MNI INTERVIEW: CGT Reform To Boost Revenue, Capital Allocation

MNI (LONDON) - Equalising capital gains and income tax rates would fill around half of the fiscal UK government’s fiscal “black hole' while reducing misallocation of capital and labour, the director of the Centre for the Analysis of Taxation at Warwick University told MNI.

With capital gains tax rates running at between 20% to 28% for individuals on the higher 45% income tax rate, estimates of revenue gains from equalising the two regimes run from one to two pennies on the pound, or GBP7-14 billion, noted Arun Advani, also a member of the Office for Budget Responsibility’s advisory panel.

This means that CGT reform alone could fill approximately half of the GBP22 billion “black hole” identified in July by Chancellor Rachel Reeves between projected revenues, expenditure and her goal of having debt falling in five years’ time, Advani said. (See MNI INTERVIEW: UKFiscal Headroom Only Clear After Spending Review)

While at first glance, raising CGT rates is hard to square with the pledge to boost productivity made by the chancellor, who is set to present her first budget in October, Advani noted that tackling misallocation is a major theme for the head of Reeves' Council of Economic Advisers, the LSE and MIT productivity guru John van Reenen.

In recent work, Advani and co-authors have examined misallocation of capital and labour resulting from setting CGT at a lower rate than income tax.

Examples include how in 2016 a pre-announced clampdown on so-called “phoenix” companies – which are temporarily closed down to take advantage of lower rates of tax on capital gains than on dividends, before later being resurrected -- resulted in a “huge spike” in liquidations. In 2010 a CGT allowance increase resulted in more investors retiring early.

CGT INCENTIVES

If the structure of capital gains tax incentivises people to hold investments for only a limited time before divesting, that is what will occur, said Advani, noting that the tax is “is concentrated among pretty sophisticated, wealthy people,” while if lower earners have assets such as shares, they tend to hold them via tax-free ISAs.

Advani's preferred option for CGT reform is to equalise the tax rate with the marginal income tax rate, together with an allowance. This latter could be either for inflation or via a rate of return allowance (RRA), with a long-running academic debate over the relative merits of the two alternatives. (See MNI INTERVIEW: Fast Rates Transmission Argues For BOE Caution)

"In recent years, the inflation allowance would have been much more generous because of the big spike in inflation for a couple of years. That might mean that the government's actually more in favour of doing that, because they can say to people, look, there's lots of you get taken out of the capital gains tax if we're doing reform," Advani said

A clear benefit, though, of RRA for investors "is not having to worry what the cost of borrowing is - I am going to get an allowance for that cost of borrowing." Advani said, adding "I am probably more in favour of a rate of return now, but I think either would be a good thing."