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The productivity cost of low Capital Gains rates

Arun Advani, Helen Hughson, Johnathan Inkley, Andrew Lonsdale and Andy Summers (2024)

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9 October 2024 – Equalise Capital Gains Tax rates with Income Tax rates to support productivity and growth, argues new report from the Centre for the Analysis of Taxation (CenTax).

At least half of all capital gains are actually income from work. The top rate of tax on work is 47%, while for capital gains it varies between 10% and 28%. The preferential rates offered to capital gains encourage work through personal service companies, to allow income from work to be taxed at these lower rates.

Almost all gains on unlisted shares (89%) comes from companies with apparent average annual returns above 100%. While a small number of individuals might by chance consistently double their money year after year, this overwhelming pattern is clearly indicative of returns coming from work not capital.

This pattern is true even for many large gains. A third of all large capital gains (>£5 million) from businesses had initial investments of under £500.

HMRC attempts to clamp down on this behaviour have helped to highlight some of the problem. A pre-announced 2016 reform that aimed to make it harder to regularly pay out income as capital gains, led to a tripling in the rate of company liquidations. Since the CGT rate itself was unchanged, this behaviour can only be explained by ‘forestalling’, as individuals attempted to benefit from CGT treatment one final time before the new rules were in place.

These findings come from new research by the Centre for the Analysis of Taxation (CenTax). This used de-identified administrative data from HMRC to examine the share of gains which appear to be income, as well as information on company liquidations from Companies House linked to company characteristics from the Bureau van Dijk’s Orbis database to study responses to past anti-avoidance reforms.

Arun Advani, Director of CenTax and Associate Professor at University of Warwick, said: “Although people tend to assume higher Capital Gains Tax rates are bad for investment, they too often miss that lower rates are bad for productivity and growth through the effect on how people work. Equalising rates with Income Tax, and providing an investment allowance to support investment, could square the circle by raising money while supporting growth.”

Andy Summers, Director of CenTax and Associate Professor at LSE, said:
“Reams of legislation exist just to police the boundary between capital gains and income. Equalisation would be a massive simplification, by allowing these to be eliminated at a stroke.”

Andrew Lonsdale, Research Economist at CenTax, said:
“The fact that one in three business disposals with over £5 million in gains had less than £500 originally invested makes it clear that low Capital Gains Tax rates are being regularly applied to returns that aren’t actually from capital.”

ENDS

Notes to editors

  1. CenTax Policy Brief The productivity cost of low Capital Gains Tax rates by Arun Advani, Helen Hughson, Jonathan Inkley, Andrew Lonsdale, and Andy Summers will be published at 0.01 on Wednesday 9 Oct 2024 on the following link: https://centax.org.uk/wp-content/uploads/2024/10/AdvaniHughsonInkleyLonsdaleSummers2024_ProductivityCostOfLowCapitalGainsTaxRates.pdf
    Embargoed copies of the report are available from:
    press@centax.org.uk.
  2. The Centre for Analysis of Taxation (CenTax) is a new centre dedicated to improving public understanding of tax policy and helping to design better a better tax system, by generating evidence that is rigorous and relevant to policymakers and the public. CenTax is led by Dr Arun Advani (University of Warwick) and Dr Andy Summers (LSE).
  3. This research was funded by the Nuffield Foundation ‘Reforming Capital Gains Tax’ grant (GE/FR-000024377) grant and the Economic and Social Research Council (ESRC) through the ‘Taxing the Super Rich’ grant (ES/W001683/1). CenTax receives core funding from abrdn Financial Fairness Trust and the Thirty Percy Foundation.
  4. This work contains statistical data from HM Revenue and Customs (HMRC) which are Crown Copyright. The research data sets used may not exactly reproduce HMRC aggregates. The use of HMRC statistical data in this work does not imply the endorsement of HMRC in relation to the interpretation or analysis of the information.