Despite requests not to "fly kites" ahead of the Budget, one rumour that continues to circulate is that capital gains tax (CGT) could once again fall into the Chancellor's sights. That may mean further tinkering as we saw in October 2024, or perhaps a more ambitious move to realign rates with income tax.
With the public finances under pressure, increasing CGT may appear an easy way to raise revenue from investors. The reality however is often rather different, and history suggests that higher CGT rates do not automatically translate into higher tax receipts because unlike income tax, CGT is essentially a voluntary tax. It is only paid when an asset is sold, giving investors considerable flexibility over when they choose to realise gains. Faced with a larger tax bill, many simply decide to delay disposals thus reducing the number of taxable transactions.
The consequences extend beyond individual investors. Capital is most productive when it can move freely between opportunities. Higher tax rates can create a "lock-in effect", encouraging investors and business owners to hold assets for tax reasons rather than economic ones. Money that could be recycled into new businesses instead remains tied up in existing investments. Ironically therefore the Government could end up undermining the very revenue it hopes to raise. If investor behaviour changes sufficiently, the reduction in transactions may more than offset the gains from a higher tax rate.
With Britain already struggling to encourage investment, innovation and risk-taking, higher rates of tax could also make it a less attractive place to build and exit businesses. None of this is to argue that CGT should never change of course, but for a government that needs growth just as much as revenue, a significant increase at this stage risks becoming a bad bet.
Capital at risk.
