What's Sunakism? Watch the capital gains tax rate

Some tax increases will be the boiling-a-frog sort. By freezing tax bands and tax-free thresholds (such as on inheritance tax), the Treasury will benefit from the inflationary “fiscal drag,” bringing in more revenue without having to tinker with rates. That approach isn’t risk-free, however. Such arbitrary hikes make taxation unpredictable and can undermine public trust. Fiscal drag alone also won’t get Sunak to where he wants to go.

A bigger clue into Sunakism may come from a tax that generally delivers only a small share of revenue. An overhaul of the capital-gains tax (CGT) has been mooted for a while and was recommended by the Office of Tax Simplification in 2020 after the Treasury ordered a review. Sunak ultimately decided against acting. The opportunity may be harder to pass up this time.

Lightly taxing capital gains has long been a bedrock of liberal economic thought as a way to encourage investors and reward risk-taking that can contribute to economic growth. There are also fairness arguments. Gains are often made on assets that are purchased with taxed income. A lower CGT also compensates for the fact that some of the gains in an asset sale will be nominal instead of real because of inflation. And higher capital-gains tax on publicly traded shares could also be said to be inefficient since a company’s profits are already taxed.

More recently, however, the orthodoxy has come in for questioning and not just from those arguing it’s unfair to tax earned income so heavily compared to unearned income. Questions of efficiency are getting a bigger hearing. Half of all taxable capital gains in Britain come from carried interest in funds (taxed at 28%), share-option schemes or other investment that is related to regular employment rather than entrepreneurs flying by the seat of their pants, according to a Resolution Foundation study.

The US has taxed capital gains for more than a century, but Britain had no capital gains tax until the 1960s under Labour Chancellor James Callaghan. The Tories have form on increasing capital-gains tax. Margaret Thatcher’s tax-cutting chancellor Nigel Lawson aligned capital gains tax with income tax in 1988, giving Britain the world’s highest CGT at 40% for top-rate taxpayers. Labour Chancellor Gordon Brown brought it down to 18% in 2008, before Osborne hiked it to 28% in 2010.

Britain’s system has become a muddle of mixed incentives. Primary residences are exempt (changing that would be political suicide), but other assets, from shares to second homes to art, over a tax-free allowance, are subject to tax. Top-band taxpayers pay 20% on gains, while lower-rate taxpayers pay 10%. There are different rates for disposals of non-primary residential property (28% and 18%), for trustees of someone who has died, for gains that qualify from a special “business asset disposal relief” and from dividends. The way the tax is calculated has also changed over the years.

There is something to be said for simplifying the system where incentives can distort decision-making (just look at the difference in the way salaried and self-employed or owner-manager income is taxed below), but what about the risk of unintended consequences? Raising the CGT in line with income taxes would put UK rates ahead of its peers, bringing the risk that assets and well-heeled taxpayers would simply redeploy elsewhere. , head of international tax at Anderson, warned back in 2020 that doing so would be tantamount to “the Conservatives signing their own death warrant.” Given that the CGT brings only a small share of total revenue, is that a risk worth taking?

Warnings of an investment retreat might be overblown or could at least be mitigated. Research from the found that while businesses respond to tax incentives in deciding how and when to realize gains, capital gains tax does not impact the amount of income they create or levels of investment.

Still, there are other consequences to consider. Increasing CGT in line with income tax could mean investors hold onto assets for longer, reducing the Treasury’s take. Taxpayers, ever creative, would be incentivized to hold assets through their companies to take advantage of lower corporation tax. And any change would have to be introduced quickly to avoid a mass disposal of assets now ahead of the increased taxation.

Reducing or eliminating the tax-free allowance is a possible change, but that means increased administrative costs for little gain. Aligning the CGT with the  (which is tiered from 8.75% for basic-rate taxpayers to 39.35% for the top band) would raise substantially more revenue (though far lower than the estimated  if it were taxed as salaried income) while also maintaining the core principle that capital gains should be taxed at a discount to salaried income.

Most chancellors tinker with tax rates, move thresholds or introduce narrowly targeted levies or relief. As chancellor, Sunak displayed a penchant for the kind of tinkering that added complexity but for unclear gain. The question for Sunak and Hunt now is whether they are bold enough to go for a tax reform that reduces complexity without discouraging the drivers of growth, whether on CGT or elsewhere. Doing so will mean accepting a heap of criticism.

As Alastair Darling, a former chancellor, told an Institute of Government study on the issue, “The only popular tax in this country is the tax that somebody else pays.”