Tax reform on the cards?

To say that the devil is in the detail barely scratches at the issue. The RP proposals, set out over 150 pages, are in fact a broad package which includes increasing vehicle excise duty, freezing income tax allowances, increasing Corporation Tax, removing or reducing CGT and investment income reliefs, increasing council tax and extending VAT to private school fees. If one ignores the fiction that national insurance is not a tax on income, the proposal really involves raising taxes on income by 1% for everybody, and by 4% for those with pensions, investment income or total income above the upper earnings limit. Technically this could be squared with the manifesto promise not to raise the rates of Income Tax, National Insurance and VAT, but on a practical level it is probably not a package which would sit happily with voters, nor is it easy to think of a better way to suck discretionary spending out of the economy and turn a recession into a full scale slump. What it does show, however, is the sheer scale of the debt that has been run up over the last nine months, and the scale of the fiscal changes which would be needed to repay it over a decade.

The OTS report (which in fact represents part I of their findings on CGT) is also a substantial tome, running to some 135 pages. There are 10 recommendations which include not only the headline grabbing rate and allowance changes, but also simplifications and measures to reduce unfairness such as the extension of the chattels exemption, the abolition of the CGT uplift on death, a new rebasing year and/or return of indexation allowance, extension of holdover relief and replacement of Business Asset Disposal relief with something more akin to the old Retirement Relief

The OTS review also acknowledges (though perhaps not sufficiently) that the yield from CGT is particularly susceptible to behavioural changes. It notes that at the lower end of the spectrum around 50 times as many taxpayers make gains very close to the annual allowance compared to those making gains £1,000 more or less than that amount. Clearly these people are utilising the allowance in full, probably within share portfolios and are effectively mitigating the impact of inflationary gains, to some extent. As the report acknowledges, many of these individuals (some might feel virtually all of them) would simply change their reinvestment policy to achieve annual gains within a new level of allowance, so the revenue raised might be negligible.

The report may also underestimate the extent to which CGT is largely a voluntary tax. It only arises on the disposal of a capital asset and practitioners will know that the bulk of CGT enquiries start with “if I sell this land/property/painting/ shareholding, how much tax will I pay?” Note that the question normally begins with the word “if”. Where the answer is unacceptable to the vendor, the result is often to hold on to the asset for the longer term – there is no immediate compulsion to sell, rules might change and the proceeds after tax may be insufficient to acquire a similarly attractive investment. Even at current rates of CGT many vendors find the tax charge unacceptable – if CGT rates double there is a real possibility that the revenue raised from the tax might reduce rather than increase.

It should be pointed out, of course, that neither of these reports is anything but useful information for the chancellor, and it seems extremely unlikely that either will be adopted in full – according to the Times, a treasury source said of the OTS report that “it will not have a bearing on any decision by the chancellor.” Nonetheless, there remains a considerable hole in the public finances which will eventually need to be filled. The slow burn from long term changes to CGT, which might initially touch few taxpayers but will become more important with time, cannot be ignored.