Opinion: Liberal Democrats must not compromise on fairer taxes

Today, the Social Liberal Forum has published an open letter to Nick Clegg and Danny Alexander expressing our concerns prior to the emergency budget which will be unveiled next week. By coincidence, Simon Hughes, Malcolm Bruce and Lord Oakeshot are reported in the FT today expressing similar sentiments on capital gains tax.

The SLF letter covers a lot more ground than CGT including socio-economic inequality, income tax and VAT. But it is a fundamental issue which, more than anything else, will determine the future direction of the coalition. For the past month, Tory backbench MPs and the rightwing press have been falling over themselves to denounce the policy. It was central to the Telegraph’s decision to out David Laws and their subsequent attacks on Danny Alexander. Worse, government ministers have been hinting that they will indeed give ground to the likes of John Redwood and David Davis.

This would be a dreadful mistake. Not only would it leave an even bigger hole in the government’s finances which will need to be filled by either other taxes or further spending cuts, it will bring into question the legitimacy of the coalition agreement itself. If Nick Clegg capitulates on such a crucial issue, so early in the life of the regime, it will send a clear signal to the coalition’s opponents on the right that anything goes. He simply cannot afford to look so weak at this stage.

The arguments of the anti-CGT harmonisation campaign are spurious at best. John Redwood can’t make his mind up whether he wants to encourage long term investment or maximise CGT revenues and thus encourage the exact opposite. David Davis seems to think that CGT is shelled out by the working classes on their second, third and fourth homes. The Telegraph published a ridiculous scare story two weeks ago suggesting that CGT harmonisation would decimate the profits elderly people in nursing homes would gain from selling their homes, a claim which doesn’t bear even the lightest scrutiny.

Let us be clear: there are arguments for keeping capital gains tax at a low rate. But there are even stronger arguments for prioritising cuts in income tax for people on low wages and for cutting the deficit overall. The current economic climate means that sadly, we can’t afford to have it both ways. The Lib Dem CGT policy doesn’t even raise that much revenue: our manifesto costed it at £1.9 billion – significantly less than a penny on income tax.

We have already compromised on this policy: that’s why the coalition agreement does not include our policies on a mansion tax and limiting tax relief on pensions. There is no room for further compromise, not without revisiting both of these measures to make up the shortfall.

Danny Alexander needs to prove over the next week that he is not David Cameron’s pet ‘axeman’ and will stand up for Liberal Democrat promises. The next few days will be his testing ground.

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  • Roger Shade 14th Jun '10 - 3:25pm

    I entirely agree with this. It is clear that backbench Conservatives are desperate to undermine any attempt to introduce fair taxation. All the usual arguments, entrepreneurs fleeing the country, unfair to hardworking families, discouraging investment etc etc. I don’t believe for one moment that the so called wealth creators will rush to leave the country, if that were true other European countries like Germany, Denmark and Sweden would be bereft of talent, and why in Tory land are the wealthy the only people who work hard, people on minimum wage don’t sit on their butts. Lib dems mustn’t compromise on fair taxation, this country is one of the most unequal of all developed countries, research shows that inequality undermines success both economically and socially. Nick and Vince must also remember their promises to crack down on tax avoidance, which could make an enormous difference in repaying the deficit, if theTreasury’s estimates of the total loss of revenue are anywhere near correct.
    I think we should also be extremely worried about the possibility of increases in University tuition fees at a time when we need more not less well educated individuals to move our economy forward.
    All in all I cannot see the coalition lasting much longer if the Tory party insists on following a path paved with Thatcherite economics that so badly damaged our society in the 1980’s.

  • I think it’s time we defined inequality and poverty. I find the SLF blinkered in its approach to benefits and the SLF as well as the party need to decide whether we go towards a more `Swedish` style of economy or German. Clearly the British have rejected the American model. Without bringing down the deficit though we don’t have that choice.

    We also need to be far smarter at the vernacular we use and stop looking over our shoulder at potential lost votes. This is a Government that can be respected or loved but not both.

    The reason why I and the party should love the idea of raising the thresholds are fourfold:

    1. It provides further equality for the `working poor` and others on middle incomes.

    2. It gives dignity to those on low incomes by giving them more of their own money instead of having to fill in time-consuming forms for the state to shuffle money around. I know it’s hard for some SLFers to swallow but a lot of these people don’t want to have handouts from the state except for the NHS and Education services. Most people although want to feel a bond with their neighbours want to just go to work, feed their kids, watch the footie, go out and go on holiday twice a year. I know shocking isn’t it!

    3. It puts more money into the economy so that the economy can grow from the bottom up.

    4. It lifts aspirations and incentivises self-improvement and gaining qualifications and promotion

  • ROB SHEFFIELD 14th Jun '10 - 3:55pm

    I was listening to the Clegg speech just now at IOG: have to say it was the most politically partisan (non pluralist) quasi-Thatcherite guff that I have heard from anyone in the government to date- even more so than Ozzy. I am not eally sure why am I surprised but I was.

    ‘the last Labour government’ ad nauseam: good job we have Will Hutton on Dispatches tonight laying the blame for the crisis- and the deficit expanding nationalisation of private sector debt- at the door of the financial sector and in principal the banks.

    It will be interesting to see how Cleggs ever increasing stampede to the ‘non progressive’ right stacks up against the Simon Hughes’s of this world i.e. who went out the way yesterday to demand that Lib Dems actively campaign for the abolition of tuition fees i.e. not just sit on their hands on the fence as Clegg wants them to do in the inevitable vote that removes the cap.

  • Terry Gilbert 14th Jun '10 - 6:57pm

    Well done James. I agree, and I am sure you speak for the vast majority of the party in the country, and jusging from the Deputy Leader vote, for the party in the Commons too.
    @John – the idea that SLF members all fail to recognise that what matters is the interface between taxes and benefits is ludicrous – many of us have been arguing this point for years, and even Iain Duncan Smith has recently been making this point. Worryingly, Clegg did not appear to understand the issue when it was put to him by a clegyman on R4’s WatO during the campaign.
    @Rob and Geoff – I agree – Clegg seems far too eager to fall in line with the ‘small govt’ ideologues who would see the deficit as an excuse to slash public services. He appears to have little understanding of the effect of this on the vulnerable. The impact of the recession and deficit cutrting needs to fall disproportionately on the wealthy, and proportionately on the middle classes. To protect the poorest workers, progressive taxation needs to be raised, but not regressive taxation. And there need to be cuts to big spending areas like the military. Of course it will not be popular, but hey, as the right of the party keep telling us, we’re in Government now!
    @David Pollard – you have a point, but no-one has succeeded in convincing me that gains from long term investment should be taxed less than income from working. Arguments about encouraging risk taking seem nonsensical to me – we do not need to encourage reckless risk taking – that is what got us into this mess in the first place! You do, however, make a good case for taxing gains from short term investment at an even higher rate.

  • Simon Radford 14th Jun '10 - 10:56pm

    James- great article, and I hope that the SLF continue to provide a liberal voice to hold our MPs, and the coalitoon, to account in demanding that liberal priorities are respected. This approach is entirely in line with (blatant plug…) my Op-Ed a few posts down. Keep up the good work!

  • Absolutely agree with the article, and much that is in the open letter. This is a real test for the coalition. Without CGT harmonisation with limited exemptions (and following through with mechanisms to deal with tax avoidance) then raising allowances alone is clearly the opposite of progressive. Similarly, increasing VAT would be a dreadful alternative.

    Some of the arguments advanced by the reactionary Right against increasing CGT are breath-taking in their wrongheadedness. Even arguments with some superficial plausibility – such as those relating to BTL – are not really sustainable if you place them in broader context and argue that it is better for the longer term health of the economy if some of this investment is diverted into productive assets rather than inflating house prices.

  • Anthony Aloysius St 15th Jun '10 - 12:25am

    “Similarly, increasing VAT would be a dreadful alternative. “

    Does anyone really still think VAT _isn’t_ going to be increased?

  • Anthony Aloysius St 15th Jun '10 - 12:48am


    I stand corrected. I assumed it was a given. I only hope you’re right.

  • actually, I don’t recall ANY of the parties ruling out a VAT rise; they all said: “we have no plans to raise VAT”, carefully avoiding to say “we WON’T raise VAT.”

    I’m not looking forward to a VAT rise, but then at least with VAT you can decide to some extend to spend or not; with a rise on income tax (basic rate) or NI, you have no choice, the money is already out before you get paid.
    And the raise of the personal allowance threshold would compensate for the lowest paid people (I didn’t get the rise to be to make people better off, but to compensate for rises/cuts in other areas).

  • Andrea Gill 15th Jun '10 - 1:52am

    We cannot seriously expect this government to deliver all of our policies.

    Firstly because this is a coalition, and to spit dummies and expect to get our way would de facto prove we’re actually incapable of being PART of a coalition & thus demolish our hopes of ever achieving PR (what’s the point, we couldn’t handle not having our own way and would be better off eternally sulking and whingeing in opposition!) and

    Secondly, because we NEED to differ with this government on some policies. We must have clear areas where we can, during the next general election, say this is how WE would have done it, had we had more seats etc. Otherwise, why would anyone vote Lib Dem if we are not seen as having some different or better policies to what a Tory majority coalition can achieve?

  • Andrea Gill 15th Jun '10 - 1:54am

    As for VAT, I sincerely hope they do NOT raise it. Just to spite Ed Balls, surely that must be worth it?

  • Anthony Aloysius St 15th Jun '10 - 2:20am

    “And the raise of the personal allowance threshold would compensate for the lowest paid people …”

    Except that it wouldn’t, because it’s now just a long-term aspiration. Aspirations butter no parsnips.

  • Patrick Smith 15th Jun '10 - 7:56am

    The facing down of the real `structural Deficit’ is now central to the coming Budget but ought not prevent a stark move towards help for the poorer earners and over 65 year old pensioners and the least off 4 million low earners at the behest of a new regime of progressive `Fair Taxes’.The taxing principle should be making those with broader shoulders paying more and allowing prper help to the poorest members of our community including small businesses.

    A new banking levy and separation of retail from the worst excesses of commercial banking practice should also be targeted next week.

    It was not the fault of the lowest paid workers that gave licence to unprecedented roulette wheeling by the City and the largesse of those MP`s now held to account by the imbroglio of the `Expenses Scandal’ over the last Government.

    I support higher taxes on CGT for the higher earners as this should help with the new progressive `Coalition Agreement’ target for the £10K fairer tax threshold for those who have most to gain in percentage terms on lower earnings from paying less tax.

  • Matthew Huntbach 15th Jun '10 - 9:57am

    The quickness of the monied classes to pick up on this and fight back using their media dominance illustrates well the problems we face in building a fairer society. Nick Clegg did a blithe hand-waving exercise about “cutting loopholes” in the run-up to the election to explain how we could cut tax paid by average and below average earning workers, but now see what happens when you try to do it.

    This is open class warfare, we need to recognise that. Although those campaigning against harmonising CGT with tax on other income claim such thing as the CGT tax rise is an “attack on the middle classes”, it is nothing of the sort. It is a tax primarily paid by people right at the top of the wealth scale, our plan to pay for a higher basic income tax allowance by such things as this is actually a plan in favour of the middle class against what I would like to call the “upper class”. We have somehow allowed the term “upper class” in this country to be used in such a limited way it applies to almost no-one. That enables these false claims to be made about things which are detrimental to the top 10% by wealth or even the top 1% to be described as “attacks on the middle class”. That what we plan is favourable to the real middle class is shown by the fact we have also been attacked from the left for it, as they say (not incorrectly) that higher tax allowances don’t do anything for those who don’t pay income tax anyway.

    You can see how much this means to them by the readiness they had to organise a campaign against the CGT rises, whereas to most ordinary people, including anyone who is REALLY middle class, is an obscure technical issue that matters little to them. What we are getting here is howls of anguish from very wealthy people whose lives will be made slightly less comfortable by being asked to pay a bit more tax. So much of it is really pathetic when one considers how much more suffering will occur because of expenditure cuts. I have read so much in the Telegraph etc which is really insulting to those who will suffer far more in this economic climate. More offensive still is all these claims that somehow people making money out of puffed up house prices are somehow doing everyone else a favour. They drive up house prices so ordinary people can’t afford to buy, because buy-to-let people can pay more, then they think they are doing those squeezed out a favour by renting to them. It is just this sort of non-productive investment in property that has led this country to its economic mess. The claims that CGT is a tax on productive investment is rubbish, by far the bulk of it goes on things like property price rises which are nothing to do with entrepreneurial investment.

    The old socialists used to say “if only our class fought as hard for its interest as they do for theirs”, and there is some truth in that on this issue. The Social Liberal Forum is quite right to recognise harmonising CGT with other income tax as a key battle we must win. It is a defence of the ordinary people of this country, all those whose income is primarily from work against the tiny minority whose income is primarily from investment – and it is aimed at non-productive investment of which there is too much here. Those fighting against us are like the old style trade unions defending privileged fiddles and threatening to cause misery by strikes and walk-outs if anyone touches them on it.

  • Malcolm Todd 15th Jun '10 - 10:30am

    Serious question:

    Has anyone got a convincing (eivdence-based) argument against this report on the effect of raising CGT?

    Before rushing to answer, have a look at these wise words from Iain Roberts.

    And before anyone rushes to the ad hominem — I’ve never had a taxable “capital gain” in my life, I’ve never been a higher-rate taxpayer, and I’d support massively increasing the taxation of home ownership, despite the fact that the paper profit on the house I’m sitting in is by far the most significant asset I own. I’m just beginning to waver in my initial easy assumption that the anti-CGT campaign is all about rich people protecting their privileges.

  • gramsci's eyes 15th Jun '10 - 10:33am

    Of course you will not compromise , you will cave in.

    It would be funny, if not so tragic, to see Keynesians such as Cable who understand the requirement for demand to be stimulated, undermine demand by undermining confidence with scare stories and huge cuts. Be careful what you wish for , you might just get it.

    Already we see the agenda with “gold plated public servants (AKA a teacher of 40 years) and those workshy claimants and their feral childen. Hardly Galbraith’s good society. They should be punished after all for the sins of the bankers.

    It’s all about the undeserving poor. Ever wondered about the undeserving rich.

    Here’s two policies : Turn the tax question to the few hunded landowners in the UK who own most of the land and get billions every year. The queens civil list is a drop in the ocean to what she gets in other subsidies & have a look at how much the Duke of Westminister gets from the public purse for the burden of all that high value land.

    Tuition fees : £20k tution fee if you went to a private school – Why allow people to spend that a year in order for them to access the top uni’s, and then we give them it at pubic expense for £3.5 k a year.

  • I read most of that CGT PDF now, however it seems a bit naive to assume that the CGT rate is the ONLY thing influencing tax revenue – how many people could afford to speculate a bit on the stock market or with second properties, say 50 or 100 years ago, vs today?

  • Malcolm Todd 15th Jun '10 - 3:05pm

    But Andrea, the report isn’t talking about what happened “50 or 100 years ago”; it’s talking about the interplay of tax rates and tax take throughout the 1970s, 1980s, 1990s, and 2000s — including specifically the effect of the cut in CGT rates in Britain introduced by the Labour government in 2002.

    It’s vitally important that we get this right, if it’s supposed to be part of the tax realignment involved in increasing the income tax threshold. Otherwise, we’re just going to blow a bigger hole in the deficit while doing (at best) less than we think in terms of equalising the treatment of high and low earners.

  • Malcolm, there’s also another (moral?) element about taxing earned and unearned income – with the latter being one that sould be taxed before the former (to my mind).

    Although the anti-CGT people will no doubt point out that the original asset is purchased from after-tax earned income, or transferred subject to IHT or transfer-CGT, so would have been taxed twice.

  • Malcolm Todd 15th Jun '10 - 3:50pm

    Yeah, but the moral argument becomes moot if raising the tax rate doesn’t actually produce any tax; and if the tax take actually falls, you end up having to tax “earned” income even more…

    We should try at least to make some sort of distinction between “good” and “bad” capital gains: the gains we make from appreciation of value in our houses are utterly unearned, and yet will remain untaxed. There’s probably greater injustice there than in the ability (perhaps exaggerated?) of a few spivs to manipulate the tax system for their advantage — but “middle England” are of course all homeowners so we daren’t tackle their (our) perk.

  • Andrea Gill 15th Jun '10 - 3:52pm

    @Malcolm – my point was more that outside circumstances need to be taken into account too, and at least going by the people/their families that I know who own shares etc nowadays didn’t own them back then, were not in a position to own second homes etc.

    I would fully support a model that for example exempts pensioners or long-term savers from the CGT raise, however for short-term assetts it is simply not fair to have the glaring loophole that allows tax avoidance by declaring income as CGT.

  • Malcolm Todd 15th Jun '10 - 3:59pm

    “glaring loophole that allows tax avoidance by declaring income as CGT”

    Ah, now that’s a fair point: but surely the answer is to deal with the loophole (by tightening definitions, for example), rather than to change the whole basis of the taxation? After all, closing loopholes was always part of our pitch, and if the CGT rules are genuinely being abused in this way it shouldn’t be beyond the wit of the Treasury to do something about it.

  • Andrea Gill 15th Jun '10 - 3:59pm

    @Malcolm – I do feel this can only work as part of an overall restructuring of the tax and benefits system, and I do hope that as Simon Hughes said today, this will not be a hike up to a threefold level in one go, but a gradual process that allows ongoing assessment of the impact.

  • Matthew Huntbach 15th Jun '10 - 4:00pm

    It is a pity that the Adam Smith Institute appears to pay very little attention to the principles put forward by Adam Smith, such as his comments on fairness in taxation. If they were truly into promoting what Adam Smith actually wrote, they would be forthright in favour of land value taxation. That would deal better with some of these issues than just CGT on capital gains on property, but seeing the ferociousness of the class warfare against us here, how much more it would be if we were to introduce truly fair taxation of the land?

    The pdf given here is really quite weak, it does not give nearly enough attention to considering the real reasons behind the correlations observed, and the observations have a fair amount of cherry picking anyway. CGT income goes up and down with booms and busts, rather obviously – consider the huge volume of house sales when the property boom was peaking and the slump when it fell, and the doubling of income that is obtained when house prices double. Indeed, it looks to me like a good part of the correlation reported in the document is actually due to the property boom and bust cyle.

    What is actually being said is that people will hang on to assets when profits from a sale will be taxed higher, and sell them when the tax is reduced. So, of course, if you slash CGT you will see a temporary rise in income as people rush to make sales, particularly if it was hinted the cut in CGT was made in order to produce such an effect. We can see how damned stupid was the New Labour government to slash CGT at just the time when the lending-built boom should have been slowed down and not sped up. At the end of the document we can see what the Adam Smith Institute is saying – if CGT is raised, people will hold off making sales on the supposition that once those nasty LibDems who insisted on it are out the way, CGT will be slashed again. The warriors of the upper class will build on this, they will be able to say “look – you did not raise much through higher CGT” when sales fall as people initially hold off – but really that would be all the more reason to hold on to the higher CGT.

    Encouraging the finance of income at pension age through investment in property is a disaster, which is why higher CGT even if it were revenue neutral in terms of direct income is a good idea. We want investment in something that is going to keep the economy going, not investment into something that is going to cause family breakdown and misery, which is what investment in high house prices is. Easily accessible and stable housing is the first step in building an economy where people are free to be entrepreneurial. If your housing is secure, you can pay more attention to taking risks trying to make money elsewhere. If you’re a slave to a high mortgage, you can’t.

    A particularly preposterous thing in the pdf is the statement that CGT is bad because it is a “tax on the old”. The old here are screwing the young by selling property at prices far above what they paid for it when it was more available in their youth, if they were not, there would be no CGT to pay. We may observe that income tax is a tax on the young, because the young are more likely to be working, and we find the likes of Mr Willetts suggesting that the young should treat university tuition fees as just more income tax on them.

    So, what is being proposed here by the Adam Smith Institute is all part of that loony approach to economics which has got us into our current mess – that somehow the economy can be made to run by everyone buying houses off each other. As we now know, that was ultimately mainly a Ponzi scheme, which relied on pushing mortgages further and further down the scale of people who could credibly pay them off. They told us “close your eyes and believe in the Gospel of Adam Smith (as interpreted by us i.e. with the awkward bits ignored)”. So we did, and when we opened them we found we had the Gospel, and they had the ownership of us through the debts they had imposed on us promising those debts were “investment”.

  • Andrea Gill 15th Jun '10 - 4:05pm

    LOL @Malcolm – think we posted at the same time, and more or less saying the same thing.

    I was always under the impression that the CGT rise in the Lib Dem manifesto was about fairness in taxes, and to stop people declaring income (esp in financial sector) as Capital Gains and thus as Nick Clegg has said over and over again, pays less tax on this income than his cleaner on her wages. (Or his wages, I guess… let’s not be sexist!)

  • Andrea Gill 15th Jun '10 - 4:13pm

    @James – I see no reason why any exemptions shouldn’t be means-tested (the Exchequer knows how much one earns or owns surely), but those who mention people who invest in a second home or shares etc as a means to fund their pensions suffering as a result of this *do* have a point, and it would make us look rather cruel and selfish (policy-obsessed) to just sweep under the table the suggestion that not everyone who ever has to pay CGT, is fatcat banker or rich snob.

  • Malcolm Todd 15th Jun '10 - 4:31pm

    James — I don’t think the idea is that pensioners should generally pay less tax than a younger person. The point is that one (relatively secure) way of saving for retirement is to do it through holding assets (whether a stocks and shares portfolio or capital tied up in your own business), which you sell on reaching retirement. If you just stick the money in a pension fund, your capital growth will be free of tax, but because you do it through asset ownership you end up with an apparently huge income in one year — just when you retire — which is a distortion of your real economic position. (Obviously, we’re not talking about the very poor here; the point is we’re not necessarily talking about the very rich either.)

    Matthew — yes, the Adam Smith Institute is a hang-out of right-wing loons, and they should indeed favour land value taxation (as I do). They may even favour it, for all I know; but it’s not strictly relevant to whether their argument on this issue stands up. My first reaction was also to assume that they were missing other triggers and treating one-off surges in the year before a tax rate rise as a proper baseline, but I’m not sure that’s true. Certainly there’s some correlation with economic hard times, as you’d expect; I don’t know enough economic history to tie in with their graph, and I suppose I was hoping that someone who does know more would provide some comment on that.

    As for the effects of investment in “property” — by which I assume you mean land and houses — I absolutely agree with you, as my other comments above, I think, make clear. As far as I’m aware, there is no coalition plan to confront the huge middle-class tax break on home ownership; indeed, our party’s one proposed early step in that direction, the rather bastardized but worthwhile “mansion tax”, has been dropped — almost as if some people never wanted it in the first place…

  • Alex Sabine 16th Jun '10 - 2:15am

    A potted history of CGT might help us to understand how we’ve got to where we are:

    – It was introduced by the Wilson government in 1965 at a flat rate of 30%, at a time when earned income was taxed at a standard rate of 41.25% rising to over 90% at the top end. Until the late 1980s CGT remained at a flat 30%, while earned income was taxed heavily. However, capital ownership was taxed arbitrarily through periodic one-off capital levies and investment income (as opposed to capital gains) were subject to a surcharge on top of the prevailing income tax rates.

    – Although the tax rate of 30% was not particularly high compared to the punitive rates that applied to income, there was no allowance for inflation – so tax was being levied on purely inflationary gains as well as real gains. This often had the perverse result that the longer you held an asset, the higher the effective tax rate would be – and in the rampant inflation of the 1970s, could easily lead to confiscatory taxation. So CGT was in practice much higher than 30% but in an arbitrary way depending on the rate of inflation over the period that an asset had been held.

    – In 1982, Tory Chancellor Geoffrey Howe introduced an indexation allowance, ensuring that only real gains – those in excess of inflation – were taxed. The rate remained at 30%. (Howe had reduced the basic rate of income tax from 33% to 30% in 1979, so CGT was equal to basic rate income tax, but high incomes were taxed at 60%.)

    – The next Tory Chancellor Nigel Lawson is remembered for his dramatic 1988 budget, which slashed income tax to 25% for basic rate payers and the top rate to 40%. But Lawson was also a serious tax reformer, and certainly the last Chancellor who left a more rational tax system than the one he inherited.

    He decided there was no good reason to tax capital gains more lightly (or heavily) than income, so abolished the flat rate and instead taxed gains at marginal income tax rates. In light of the current disquiet on the Tory backbenches, it’s enlightening to read how he justified the move in his budget speech:

    (from Hansard)

    “Strictly speaking, this should not be a tax on the original capital at all. Nor is it, so far as gains which have arisen since 1982 are concerned, thanks to the indexation provisions introduced by my predecessor in 1982 and extended in my 1985 Budget.

    But for gains that arose before 1982 the tax falls largely on purely paper profits resulting from the rampant inflation of the 1970s. In other words, it bites deeply, and capriciously, into the capital itself.

    This has long been recognised as manifestly unjust. Indeed, from the time I first entered the House I have argued that capital gains tax should fall only on real gains and not on paper gains.

    I have therefore looked hard to see if the indexation provisions could be applied right back to the inception of the tax in 1965. Unfortunately, they cannot. The necessary information is in many cases no longer available.

    Accordingly, I have decided to bring the base date for the tax forward from 1965 to 1982. That is to say, for all disposals on or after 6 April, that part of any capital gain which arose before April 1982 will be exempt from tax altogether for individuals and companies alike.

    This Budget thus ends once and for all the injustice of taxing purely inflationary gains. This will benefit the economy by unlocking assets which have been virtually sterilised because of the penal tax that would have arisen on any sale. And it will help many small businessmen and farmers in particular.

    At present, the first £6,600 a year of capital gain is tax free. The relatively high level of this threshold stems from the substantial increase my predecessor made in 1982 explicitly as rough and ready partial compensation for the continued taxation of pre-1982 paper gains.

    Now that I have taken pre-1982 gains out of tax altogether, I propose to reduce the capital gains tax threshold to £5,000. It should also be borne in mind that, with the introduction of independent taxation in 1990, a husband and wife will each have their own threshold for capital gains tax as well as for income tax.

    Rebasing the tax so as to produce a fully indexed system makes it possible to bring the taxation of gains closer to that of income.


    “In principle, there is little economic difference between income and capital gains, and many people effectively have the option of choosing to a significant extent which to receive. And in so far as there is a difference, it is by no means clear why one should be taxed more heavily than the other.

    “Taxing them at different rates distorts investment decisions and inevitably creates a major tax avoidance industry.

    “Moreover, at present, with capital gains taxed at 30 per cent. for everybody, higher rate taxpayers face a lower—sometimes much lower—rate of tax on gains than on investment income, while basic rate taxpayers face a higher rate of tax on gains than on income. This contrast is hard to justify.

    “I therefore propose a fundamental reform. Subject to the new base date, capital gains will continue to be worked out as now, with the present exemptions and reliefs.

    “But the indexed gain will be taxed at the income tax rate that would apply if it were the taxpayer’s marginal slice of income. In other words, I propose in future to apply the same rate of tax to income and capital gains alike.”

    – Lawson’s reform lasted for a decade and worked perfectly well. But in 1998 Gordon Brown, that inveterate tax tinkerer, decided to make a cut in CGT the centrepiece of his pro-enterprise agenda. He therefore introduced taper relief, which gave taxpayers an increasingly generous discount on their CGT bill the longer they held an asset, with a bigger discount for ‘business assets’ than ‘non-business assets’.

    The snag was that he abolished the indexation allowance, but because the taper relief progressively reduced the effective tax rate the longer you held an asset, he could argue that his system was actually more generous than the old one.

    It was, but in a less rational, more arbitrary way which made an already complicated tax even more complicated. He argued that his reforms would stimulate long-term investment, but rather undermined this objective by subsequently reducing the length of time you had to hold an asset before benefiting from the lower rates. (Taper relief was made more generous in 2000 and 2002.)

    – By 2007 it was clear that having a tax rate of 40% on earned income but 24% and 10% on capital gains (non-business and business respectively) was problematic. On the plus side, it probably did stimulate entrepreneurship, but it also distorted investment decisions in undesirable ways and had become an invitation to income tax avoidance.

    In 2007 Alistair Darling replaced the system of taper relief and instead levied a flat rate of CGT of 18% – returning to the pre-1982 system of a flat rate with no allowance for inflation and no taper.

    While this moved the lowest CGT rate (now the only one) closer to income tax rates, it was still lower than the basic rate and much lower than the top rate (a disparity that was made even more glaring when the 50% top income tax rate was introduced this year).

    At the same time, because he abolished the distinction between business and non-business assets in an attempt at simplification, the most obvious effect was to increase tax rates on entrepreneurs selling their businesses (from 10% to 18%) while reducing it on, for example, second home owners (from 24% to 18%).

    This (understandably) made it an easy target for business lobby groups, and Darling was forced to water down the changes by introducing an “entrepreneurs’ relief” that cuts the rate on the first £1m of lifetime gains for some business assets. So, in effect, he was reintroducing a distinction between business and non-business assets.

  • Alex Sabine 16th Jun '10 - 3:16am

    In a recent article reviewing the way CGT has evolved over the years, Robert Chote of the IFS concluded:

    Looking back, most of these changes have been attempts to balance two competing objectives: the desire to minimise the scope for tax avoidance created when capital gains are taxed more lightly than income; and second, the desire to keep capital taxes as low as possible to avoid discouraging saving and investment.

    The now Lord Lawson and the Liberal Democrats put more emphasis on the former, while the last Labour government and the current Conservative critics of the coalition put more on the latter.

    These critics also argue that many small investors have been saving in non-business assets in the expectation of generous tax treatment and that it would be unfair to withdraw it now.”

    I think it’s important to recognise that there is a serious theoretical case advocated by many orthodox economists for abolishing tax on savings and investment altogether and moving to a pure ‘expenditure tax’ system, but that would have to be part of a much more far-reaching reform package than the one that’s on the table at the moment.

    Within the basic parameters of the current system, I agree with Chote’s conclusions that:

    The Liberal/Lawson view has much to recommend it. The tax system should not distort people’s behaviour in a costly way without good reason. From this several lessons follow.

    First, the tax rate on capital gains should be aligned with the rates on earned and dividend income, ideally with a single tax-free allowance.

    Different tax rates encourage people to be paid in more lightly taxed forms and to move into occupations where this is easier. Using anti-avoidance rules to restrict how people are paid in particular circumstances is much less attractive.

    Second, CGT should not discriminate between business and non-business assets. People should be left to decide unbribed whether to put their money in a bank account, housing, shares, or into their own businesses, based on their own judgment of the risks and returns involved.

    There is an argument for taxing shares more lightly, however, because company profits that give rise to capital gains have already been subject to corporation tax.

    We should be wary of the argument that investing in one’s own business is a virtuous act deserving of subsidy in a way that investing in somebody else’s business is not. People should decide whether and how to build an enterprise on the basis of its commercial fundamentals, not its tax treatment.

    Third, we should not try to bribe people into holding assets for longer than they would otherwise wish to do – economic welfare is best served by having assets owned by the people who value them most.

    The previous government justified taper relief as a way to discourage short-termism, but encouraging people to hold assets for longer than they want is not the same as encouraging companies to undertake productive investments that may take a long time to pay off.

    [Chote points out that capital allowances are a more effective way of doing this because they specifically reduce the tax on capital investment rather than on the other factors that generate capital gains.]

    Fourth, we should tax real gains rather than the illusory gains from inflation, so there is a strong case for reintroducing indexation allowances.

    I think the last point is absolutely crucial. I would be prepared to support a rise in CGT to align it with income tax, but only on the condition that indexation allowances are reintroduced so that only real, and not inflationary, gains are taxed.

    I thought this was part of our policy, but it isn’t explicitly mentioned in party policy documents. If we were planning to go back to the Lawson system but without reintroducing indexation, that would be unfair and would almost justify some of the scare stories about ‘legalised theft’.

    While it’s true that many parts of the tax system are not indexed to inflation, it’s particularly important with CGT because the gains can accrue over many years, and the cumulative impact of even quite low inflation rates can thus be significant.

    For example, you buy an asset for £1,000, own it for 10 years and sell it for £1,500. Inflation averages 3% per year. If you sell it for £1,500, your ‘paper’ profit is £500, and your tax bill would be (say) 40% of £500 = £200. But your real profit, corrected for inflation, is more like £160 – so your tax bill actually exceeds the real profit you’ve made and your effective tax rate is more than 100%.

    This is clearly unacceptably unfair and would be economically damaging because it would mean that, although the headline rates of income tax and CGT were the same, in practice the CGT regime was much more punitive, indeed confiscatory.

    So, if we are to revert to the Lawson system, let’s do so in its entirety and not just hike the rate.

    With that caveat, in principle there is a solid case for aligning rates. The one thing you will notice when comparing international CGT rates, though, is that they tend to be a lot lower than income tax rates and few countries in the developed world have CGT rate as high as 40%, let alone 50% – presumably because capital is more mobile than labour and so tends to be taxed more lightly.

    So we do need to at least consider the argument that – whatever the theoretical merits – a big rise in CGT might actually cost rather than yield revenue. It will be very difficult to determine whether this has happened after a change is introduced, because as Chote says:

    Swings in CGT revenues from year to year often reflect the pre-announcement of rate changes and expectations of where they might go next. And we should not look at CGT revenues in isolation: perhaps the key role of the tax is to underpin the much bigger revenues we get from income tax and National Insurance.

    This is certainly true, and so I am suspicious of some of the correlations being put forward as clinching arguments by the opponents of a CGT rise. However, it is at least possible: CGT certainly does discourage saving and investment to some degree, and a big rise could therefore be expected to have behavioural effects that might offset the revenue gains from a higher rate.

    It was partly for this reason that it was very hard to cost our CGT policy at the time of the election. It isn’t really a tax change that you would choose if you’re looking for a reliable source of increased revenue that could be used to reduce the deficit or cut other taxes.

    It is defensible on broader economic grounds, but to claim that it is the essential means of funding a big rise in the personal allowance simply isn’t credible I’m afraid. It is even odder to look at it as somehow an alternative to a VAT rise, which as a much broader-based tax would obviously raise MUCH more revenue. (Of course it would have its disadvantages too, but the point I’m making is that you can’t say that the coalition is only considering a rise in VAT because it refuses to tax capital gains more heavily – the numbers are just not comparable.)

    This is a particular case of a naive tendency that some in the party have to believe that a big squeeze on “the rich” of one form or another will raise enough money to fund a broad-based tax cut for everyone else. It won’t.

  • Andrea Gill 16th Jun '10 - 5:43am

    @James Graham – if shares etc are a person’s only assetts how exactly is a personal allowance ‘means testing’? The personal allowance does not, as far as I can tell, take into account how much money someone has, but merely how much capital gains one is allowed to make before having to pay taxes.

  • Alex Sabine 16th Jun '10 - 1:44pm

    James: I’m interested to hear whether you agree that only real and not inflationary gains should be taxed, and therefore that an indexation allowance must be reintroduced. The point is that the headline rate is only part of the story with CGT, because of the significant cumulative effect of inflation.

    So one “compromise” I would not only be happy to see us sign up to, but actually think we must insist on, is that CGT should apply only to real and not paper gains.

    CGT is not intended to be a ‘wealth tax’ of the sort being loosely bandied about in the Labour leadership context, and should not be used as a kind of arbitrary proxy for one contingent on the Bank of England’s success or failure in controlling inflation.

    (I do support one particular form of tax on unearned wealth, or economic rent – a land value tax – but that is a different matter. Other wealth taxes encourage capital flight, a net loss in tax revenue, and tend to be very administratively cumbersome. Sweden actually scrapped its wealth tax a few years ago, contrary to what some on the left are claiming.)

    Secondly, what do you make of the point that international CGT rates have tended to converge in the 10-25% range (in those countries that have it at all)?

    As I said, I can support it being aligned with income tax in principle, although I think we should also scrap the 50p top income tax rate (which, as the IFS have said, is likely to raise “approximately nothing”) so that would mean top rates aligned at 40%. In practice the coalition are likely to keep the 50p rate, so I think they won’t fully align the rates but cap CGT at 40% on the basis that (a) it’s close enough to catch most tax avoidance, and (b) there is a longer-term aspiration to scrap the 50p rate anyway.

    Finally, as I’ve said, it is difficult to measure the revenue cost or yield of CGT changes, for the reasons outlined above. It follows that it is unwise to rely on it to raise the revenue required either for deficit reduction or for other – expensive – policy commitments like raising the income tax personal allowance.

    So let’s not confuse matters by linking what happens with CGT with whether or not a rise in VAT is going to be part of the budget as a deficit reduction measure.

    Also, the IFS has also frequently pointed out that raising VAT is not necessarily a regressive measure, partly because in our system many basic items are zero-rated and also because other measures can be introduced to offset the impact of a rise in VAT on low-earners while still raising large amounts of revenue.

    I’m not saying an increase in VAT is progressive as such – an increase in the basic rate of income tax would probably be more progressive, for example – but rises in VAT, like in most other taxes, mostly hit middle earners. Increasing employers’ NI, as Labour planned to do, is not progressive either and arguably would have worse economic effects.

  • Anthony Aloysius St 16th Jun '10 - 3:12pm

    “Also, the IFS has also frequently pointed out that raising VAT is not necessarily a regressive measure, partly because in our system many basic items are zero-rated and also because other measures can be introduced to offset the impact of a rise in VAT on low-earners while still raising large amounts of revenue.”

    I don’t see the logic of saying that VAT is “not necessarily regressive” because you can do other things to offset its impact. Particular as there’s a world of difference between “can be introduced” and “will be introduced”.

    As for its not necessarily being regressive because of zero-rating, I can imagine how that _could_ theoretically be the case, but if you look at the figures it’s simply _not_ the case. For example, according to this document from the ONS – http://www.statistics.gov.uk/downloads/theme_social/Taxes-Benefits-2007-2008/Taxes_benefits_0708.pdf – VAT accounted for 10.8% of the gross income of the bottom quintile of households, compared with only 5.8% for all households.

  • Alex Sabine 16th Jun '10 - 4:43pm

    I don’t see the logic of saying that VAT is “not necessarily regressive” because you can do other things to offset its impact. Particular as there’s a world of difference between “can be introduced” and “will be introduced”.

    That is a fair point, Anthony, and I should have made myself clearer. What I was getting it is that IF you implement either a rise in VAT or a reform that would broaden its base – for example, by abolishing the zero and 5% rates – you can prevent it from hurting the poor while still raising a lot of money (certainly more than we will get from the CGT changes). The IFS in fact advocates the latter reform and has shown how it could be done in a non-regressive way. However, by itself scrapping the lower rates would indeed be regressive.

    On whether VAT as it is currently structured in the UK is progressive or regressive, I have seen the ONS figures and at face value they suggest it’s regressive.

    However, as the IFS have explained (sorry to keep quoting them but they have done a huge amount of work on the way our tax system works and potential tax reforms), it’s a bit more complicated than that because of problems with the methodology underlying the figures.

    They argue it makes more sense to look at VAT as a proportion of household spending, rather than income – and if you do this then VAT is proportional or mildly progressive. This makes sense, as the goods that are zero- and reduced-rated, such as food and domestic fuel and power, are a higher proportion of the spending of poorer households than of rich households.

    They say:

    A second difficulty with the numbers relates to the way in which indirect taxes are treated, and this affects whether they appear to be regressive or not.

    People who are interviewed in the sort of surveys which underpin this analysis, and who report a low current income, tend to spend a lot relative to their current income, and therefore pay a lot of indirect tax relative to their current income.

    But this arises because the figures are a snapshot view of indirect taxes paid in a given period as a percentage of income in the same period.

    In reality, much low income is temporary, and people borrow and save to smooth out their living standards; over a lifetime, individuals cannot spend more than their income.

    As acknowledged by the ONS, we get a different impression of the impact of indirect taxes by ranking people by their level of spending.

    That shows, for example, that VAT is progressive as a percentage of spending, since zero- and reduced-rated goods (such as food, children’s clothes and domestic fuel) are necessities that are bought disproportionately by the poor.

    So the zero and reduced rates do have the effect of making VAT more progressive than would otherwise be the case – although these concessions are not a particularly well targeted form of redistribution combared to (say) tax credits or even universal flat-rate benefits, since in cash terms most of the benefits go to richer households.

    If you want an illustration about how comprehensive VAT reform could be progressive overall while still raising revenue, read this paper: http://www.ifs.org.uk/budgets/gb2009/09chap10.pdf

    The headline conclusion is this:

    Broadening the VAT base by extending the standard rate to most goods and services would remove many of the distortions to consumption decisions caused by the current system and would raise significant revenue even after more than compensating poorer households on average.

    For instance, a net £10 billion could be raised, with the rest of the revenues used to help meet the child poverty targets and compensate poorer households, households with children, those with disabilities and pensioners.

  • Anthony Aloysius St 16th Jun '10 - 10:09pm

    “They argue it makes more sense to look at VAT as a proportion of household spending, rather than income …”

    I’m sorry, but I just don’t accept that. The figures show that VAT accounts for a much larger proportion of the incomes of the poorest households, which clearly makes it regressive as far as I’m concerned. I don’t think it becomes any less regressive when you point out that people with higher incomes have more cash to spare and therefore don’t need to spend as large a percentage of their income.

    As for the point about much low income being temporary, my first reaction is that much of it _isn’t_ temporary, and my second is that hitting someone when he’s temporarily down isn’t really any more justifiable than hitting him when he’s permanently down …

  • Alex Sabine 17th Jun '10 - 5:02am

    “The figures show that VAT accounts for a much larger proportion of the incomes of the poorest households, which clearly makes it regressive as far as I’m concerned. I don’t think it becomes any less regressive when you point out that people with higher incomes have more cash to spare and therefore don’t need to spend as large a percentage of their income.”

    Even looking at VAT as a share of household income rather than spending, the percentage of net income paid as VAT is fairly uniform across most of the income distribution (deciles 2 to 9 on Treasury figures).

    The biggest exception is that the lowest decile group pays a significantly higher fraction of its net income on VAT. Given the importance to this group of the zero-rated, reduced-rated and VAT-exempt items (which together cover 45% of all spending in the UK), it is not immediately obvious what would cause such a sharp disparity between decile 1 and say 2/3/4, which does suggest the IFS have a point about the methodology.

    Fundamentally what they’re saying is that household income data does not accurately capture living standards, and as a result overstates the extent to which indirect taxes are paid by the poor (which is not to deny that most of them are regressive, especially tobacco duty).

    “Looking at a snapshot of the patterns of spending, VAT paid and income in the population at any given moment is misleading, because incomes are volatile and spending can be smoothed through borrowing and saving.

    Consider a student or a retiree: their current income is likely to be quite low but their lifetime earnings could be quite high. The student may borrow to fund spending, whilst the retiree may be running down savings.

    Similarly, many people in the lowest income decile will be temporarily not in paid work and able to maintain relatively high spending in the short period they are out of the labour market. Because their spending is higher than their current income, these people will be paying a high fraction of their current income in VAT.

    Similarly, those with high current incomes tend to have high saving, and so appear to escape the tax, but they will face it when they come to spend the accumulated savings. Because of this ‘consumption smoothing’, expenditure is probably a better measure of living standards (and households’ perception of the level of spending they can sustain.)”

    This is not a fringe view; the same point was recently made by the Social Market Foundation in its submission on how to tackle the deficit (one of its proposals being to raise VAT to 18.5%). The FT makes the same point here: http://blogs.ft.com/westminster/tag/vat/

    I’m not going to fight in the last ditch to defend the current VAT structure, and I certainly don’t relish the prospect of an increase in VAT in the forthcoming budget. But we have a £156 billion deficit, and the options are limited.

    I’m taking it as read from your previous posts that you don’t favour tackling the structural deficit entirely through spending cuts, as Vince Cable suggested was feasible last year. So some net tax rise is going to be needed.

    Hiking the main rate of VAT to 20% (as many commentators expect will happen) would raise about £12bn per year and you could use around £2bn of that to compensate low-income households. So you would raise a net £10bn.

    By comparison, even if it were to be implemented in full, our proposed hike in CGT (which wasn’t intended for deficit reduction anyway) raises £1.9bn on our own figures – and as I’ve pointed out, the revenues from CGT are highly unstable and unreliable as a means of funding other tax cuts or deficit reduction.

    (I’m not arguing against reform of CGT, just pointing out that the amount it raises is small beer, and thus it cannot be a substitute for a rise in one of the main taxes borne by the majority of the population.)

    One alternative would be to raise the basic rate of income tax by up to 3p in the £, which would be more progressive than a rise in VAT or NI. But it has plenty of disadvantages too, not least from the Lib Dems’ point of view the fact that just a couple of years ago we were arguing for a 4p reduction in the basic rate on the grounds that it helped low- and middle-income earners!

  • Anthony Aloysius St 17th Jun '10 - 8:28am

    … it is not immediately obvious what would cause such a sharp disparity between decile 1 and say 2/3/4 …

    If some clever academic can find definite evidence that the figures are wrong, fair enough. Surely that shouldn’t be too hard, as the disparity is so great. (And I wouldn’t be surprised if there were a peerage in it for them, in the present situation!)

    But I don’t think it’s good methodology to say, in effect, “I find it difficult to believe the data so there must be something wrong with them”.

    “One alternative would be to raise the basic rate of income tax by up to 3p in the £, which would be more progressive than a rise in VAT or NI. But it has plenty of disadvantages too, not least from the Lib Dems’ point of view the fact that just a couple of years ago we were arguing for a 4p reduction in the basic rate on the grounds that it helped low- and middle-income earners!”

    I agree that the CGT rise is almost too small to be worth arguing about in the context of the overall deficit.

    A rise in income tax would be my preference, but obviously it’s not going to happen – for purely political reasons. And of course I believe the old plan for a 4p cut had very little to do with helping the low-paid, and very much to do with courting middle-class voter in marginal Lib Dem/Con constituencies.

    The greatest shame is that the parties effectively connived to prevent any real choice being offered to the voters on this question, and any real discussion of the issues taking place before the election.

  • Matthew Huntbach 18th Jun '10 - 1:17pm

    Poorer people spend a higher proportion of their income on non-VATable items, so I could accept a rise in VAT as part of an overall package. It would have to be balanced by a rise in benefits to pre-empt the inflation effect, and by a rise in taxation which specifically hits the wealthier end. The line here would be to use it to sell the rise at the higher end as part of an overall deficit reduction package. Essentially, those who moaned about it would have the VAT rise hitting poorer people pointed out to them and made to look like shits for moaning.

    I’m looking around at all these flags people have out for the football. This is something that doesn’t interest me at all, to me it’s absurd to invest so much emotion in 22 men kicking a ball around. Yet in some way I can see it as a way of expressing more general loyalty to this country, not in a nasty way as high-minded liberals often take it, but in a “we’re ll in this together” way. We seem to have thrown away anything else which might make us feel we are all in this together and we have some obligation to look after those amongst us who need it and to continue what we can if we can, so football now does it. Take this in mind and consider those who are wealthy and yet moan about paying higher tax when our country is in crisis, they won’t get out of bed because of the tax levels or they’ll run away to Switzerland or wherever. This makes me feel somewhat warmer to the flag-fliers. And tells me the moaners are shits and should be made to feel like shits and treated like shits because they won’t give what they can give while others are giving more or suffering much more than a little less money to spend on luxuries, and if we are to believe those who say quick deficit reduction is so necessary for our country that’s what it’s for.

  • Alex Sabine 19th Jun '10 - 4:12am

    @James Graham

    “The short answer regarding whether I would accept any changes to the CGT plans is this: change it by all means but the party policy was clear, it was the only one of the three main tax changes in the Lib Dem manifesto that made it into the coalition agreement and that means that any deviation from it should come at the price of compromise by the Tories in other areas. Perhaps a cap in tax relief on pensions at the higher rate for example.”

    I don’t think the manifesto was explicit on whether we planned to reintroduce CGT indexation or not – but if we didn’t, that was a mistake in my view for the reasons I gave above. (If we did then clearly it would not be a concession to the Tories – although in that case I do wonder why haven’t we been quicker to rebut media scare stories that the government might tax purely inflationary gains…)

    Most economists who favour reforming CGT along the lines that we want also insist on indexation to go with it. It wasn’t such a big deal in practice when the rate was 18% and inflation was consistently low, but if the rate is to be hiked to 40% or even 50% then it is much more important – not least to achieve our stated objective of aligning CGT with income tax.

    As Lawson said in 1988, “rebasing the tax so as to produce a fully indexed system makes it possible to bring the taxation of gains closer to that of income”.

    Without indexation we would be seriously over-shooting the taxation of capital gains compared to income in a distortionary way – which is what we claim to want to stop – and causing arbitrary redistribution based on how long an asset is held (the longer it’s held, the more punitive the tax) and how successful Mervyn King is at controlling inflation.

    (As I showed above, the effects of inflation on the calculation of long-term capital gains are much more significant than the effects of inflation on income accrued or benefits received in a single year.)

    Of course, if the motive is not reforming CGT to make it more rational and equitable (and in the process raising some revenue, predominantly – although not exclusively – from the well-off), but instead a general ‘clobber the rich’ impulse with no regard for economic efficiency or indeed equity, then clearly my caveats will fall on deaf ears.

    So personally I would see reintroducing indexation as a positive modification of our policy that makes it better and fairer, not some gallant concession waranting a reciprocal response from the Tories.

    If on the other hand the CGT changes were to be watered down in ways that significantly depart from the principles behind our proposal (I’m being generous here and assuming that our principles were the publicly stated ones and not crude envy politics), then I agree that would warrant a similar concession from the Tories.

    So if (say) the John Redwood proposal of reintroducing taper relief were to be adopted, then we could rightly expect a concession on some other aspect of tax policy.

    You say the CGT proposal was the only one of our “three main” tax changes that made it into the coalition agreement. Is that so? I would have thought our single most important (and certainly most trumpeted) tax change was the £10K personal allowance, and the coalition’s commitment to raise the p.a. in real terms every year until the target of £10K is reached is about the most we could have expected in these fiscal circumstances. It’s not as if we had pledged to go straight to £10K in year one…

  • Alex Sabine 19th Jun '10 - 4:55am

    One final point on CGT: fully aligning it with income tax would require giving relief for gains on shares to reflect corporation tax already paid, mirroring the dividend tax credit in income tax.

    As the IFS explains: “The fact that the Liberal Democrats do not propose this means that the reform would actually ‘overshoot’ equal treatment: in some cases, capital gains would be taxed more heavily than income, instead of less heavily as at present.

    “In respect of higher-rate taxpayers in particular, it would replace the current artificial incentive for companies to retain profits to increase the value of the company (rather than paying them out in dividends) with an artificial incentive not to retain profits in the company – except where gains would qualify for entrepreneurs’ relief.”

    James, you also suggest one of the concessions we could expect from the Tories if we give ground on CGT would be to adopt our proposed changes to pensions tax relief. That would certainly be a major concession, since our CGT reforms were expected to yield £1.9bn while our pension tax changes were budgeted at £5.4bn…

    Unfortunately, however, our pension tax changes were fundamentally misconceived to begin with. The IFS (an independent body with expertise in these matters, not a lobby group or vested interest or the Daily Telegraph) was highly critical of them in its audit of the three parties’ manifestos, even while it gave a thumbs-up to many of our other reforms to tax structure.

    It argued our plan was “fundamentally misguided” because we were proposing reforms to the tax treatment of pension contributions in isolation from the tax treatment of the pension income they finance.

    To quote the IFS: “Pension contributions are excluded from taxable income precisely because pension income is taxed when it is received: in effect the tax due on earnings paid into a pension is deferred until the money (plus any returns earned in the interim) is withdrawn from the fund.

    “It is hard to see how it can be unfair for higher-rate taxpayers to receive 40% relief when basic-rate taxpayers receive 20% relief, yet at the same time not be unfair for higher-rate taxpayers to pay 40% tax on their pension income when basic-rate taxpayers pay only 20%.

    “If somebody is a higher-rate taxpayer throughout their adult life, it seems unfair for the tax relief on their pension contributions to be restricted to 20% and for them then to pay 40% tax on their pension income.”

    That’s an argument that we failed to refute (because by and large we chose not to engage with it), but it’s a pretty convincing one.

    One possible response would be, ‘ah, but a fair few people pay higher-rate tax during their working life but only basic-rate tax in retirement’.

    To which the IFS responds: “But it is arguable whether it is really unfair for people to receive higher-rate relief and then pay only basic-rate tax: in effect such individuals are simply smoothing their taxable income between high-income and low-income periods, undoing the ‘unfairness’ that an annually assessed progressive tax schedule creates by taking more tax from people whose incomes are volatile than from people whose incomes are stable.

    “And even if receiving higher-rate relief and then paying basic-rate tax is seen as unfair, that does not diminish the case for accompanying the restriction of tax relief on contributions with a restriction of the tax relief on pensions…

    “If relatively few individuals pay higher-rate tax on their pension income, that merely suggests that [the Lib Dem policy] would be cheap.

    “A policy that treats pension contributions and pension income asymmetrically is indefensible.”

    The IFS also rubbished our claim that our reform “is not forecast to result in a reduction in overall levels of contributions since it is anticipated that individuals will still value the basic-rate relief on contributions”, a claim they described as “patently nonsense” – strong language for IFS academics!

    As they say, “basic-rate relief is valuable, but it is less valuable than higher-rate relief. People do not just make discrete decisions whether to save in a pension on the basis of whether it is worthwhile; they decide whether and how much to save in a pension on the basis of how worthwhile it is.”

    They conclude: “While the Liberal Democrats’ proposal is more coherent than the government’s, it is still unfair and inefficient to restrict tax relief on pension contributions without restricting tax on pension income.

    “And while the Liberal Democrats’ proposal is less complex than the government’s, it would still be enormously complicated – particularly in requiring valuation of the pension promises made by employers through defined-benefit schemes.

    “Even relatively simple rules of thumb for such valuations are still likely to be complicated, and by being inaccurate would also arbitrarily favour some groups over others and therefore create both inefficiencies (from unjustified distortions) and unfairness (from unintended redistribution).

    “And the Liberal Democrats’ proposal would apply to all higher-rate taxpayers contributing to a pension, not just the 300,000 affected by the government’s reform: while a less bad design than the government’s reform, it would affect many more people.

    “The compliance costs alone of this measure would be so high as to make it an incredibly inefficient way to raise revenues from higher-rate taxpayers.

    “In summary then, this proposal would be expensive to administer, unfair and inappropriately distort behaviour; there are far better ways to raise money from higher-rate taxpayers, or to reduce the generosity of pensions taxation, or even do both at once.”

    I don’t know how to describe that assessment of a key plank of our tax policy other than “scathing”.

    Sorry to bang on about seemingly arcane matters of tax system design, but they matter and have real-world consequences.

    Now, the fact that we had a misguided policy on pensions tax relief is not in itself a hanging offence.

    But it does suggest two possibilities, neither of them very reassuring: either we didn’t fully understand what we were proposing, or we simply don’t care that it would be administratively cumbersome, economically inefficient and unfair because it only affects wealthier people and who cares about fairness to them?

    I think the link with the point I made about CGT indexation is this: by all means raise some more tax from the well-off in sensible, economically rational and fair ways, but don’t pretend that anything that raises money from the well-off is by definition fair.

    Fairness is taxation is only partly about distributional fairness in the narrow sense. Avoiding arbitrary redistribution and unjustified anomalies is also important.

    So all in all, I would rather this policy doesn’t make its way into the budget as a trade for a watering-down of CGT, on both counts.

    (A better approach to reducing the generosity of pension tax treatment in a redistributive but fair way would be to reduce the maximum tax-free lump sum that individuals can take from a private pension on retirement from its current level of £437,500 – there is no good justification for such a large tax-free amount.)

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