President Obama has announced proposals to increase taxes on the wealthy and help those on lower incomes (such as by boosting tax credits). The plans include reforms to capital gains tax (CGT): increasing its rate and ending a loophole. Should we do the same in the UK, and how do the Lib Dems’ proposals compare?

It’s worth pointing out first that the UK has already been through many CGT reforms. It was introduced in the 60s, modified by inflation-proofing in the 80s, which was replaced by taper relief in the 90s, which was in turn scrapped in the 00s. It’s important that any reform in the next parliament gets it right!

1. Obama proposes increasing their top CGT rate to 28%, as it was under Reagan. This is (coincidentally?) the UK rate, after the Coalition increased it. However, Lib Dems want to go further in the next parliament and are (with some big caveats below) right to do so. We should be seeking marginal rates equal to those on earned income, including employee and employer National Insurance, and we’re some way from that. Similarly, Lib Dems are rightly proposing to (all but) end the separate capital gains tax-free allowance – £11,000 this year. Any unused Personal Allowance should be used instead.
2. Where the US and UK systems are even more in need of improvement, and where ‘the right’ should focus, is on (returning to) a rate of return allowance you can receive without paying any tax. This might be the rate of inflation – so we’re not taxing people on savings that aren’t going up in real terms – but the theoretical backing is stronger for matching the risk-free market borrowing rate, e.g. medium-term gilt yields. If you get this right you can encourage saving, investment and equity (rather than debt) financing, without compromising on fair rates. In short, if the risk-free rate of return (e.g. gilts) is 1%, it doesn’t matter how heavily you tax the excess on a (risk-adjusted) 8% return – there won’t be a shortage of people wanting to make that investment. Such ‘supernormal returns’ are a sign of economic rent or blind luck – precisely what the tax system should target.
3. Any increases in the CGT rate beyond 28% should consider the fact that corporation tax may already have been paid on profits. Dividend taxation already accounts for this, but CGT does not. So second homes and other non-productive assets should face a higher CGT rate than shares – which comes with its own economic benefits and political appeal.
4. One of the biggest parts of Obama’s proposal would be the ending of the loophole whereby the capital gains slate is wiped clear when inherited. The UK should do the same. Even with inheritance tax, this is a perverse tax break: it favours only one kind of income and only if held right until death. As the IFS conclude, “there is no case for forgiveness of CGT on death.”We could also look at restricting entrepreneurs’ relief, which may not be worth the £3 billion a year it now costs.

The Lib Dem pre-manifesto is encouraging on much of this, but isn’t quite there, while Labour have simply hinted at returning to the taper relief system they scrapped in 2007.

There is a lot of revenue to be raised here for deficit reduction, but reform needs to be for the long term too, tackling inequality while also promoting growth and building a simpler, more coherent tax system. The above would be a good place to start. Obama’s proposals, and the rest, are unlikely to be realised in the US anytime soon: perhaps they’ll see the light of day in the UK first.

 

Originally published at http://www.libdemvoice.org/opinion-70-44293.html