With an election on the way, all parties will be looking for ways to fund their pledges. The IPPR has a proposal that should appeal to parties on both the left and the right: reform our tax system so that those who earn their income from wealth are treated the same as those who earn their income from work.
At the moment, income from wealth is taxed significantly more lightly. For example, someone who makes £100,000 in capital gains will pay about £14,000 in tax, while someone who makes the same amount in earnings will pay £33,000, or closer to £40,000 once employer National Insurance contributions are taken into account. And the biggest beneficiaries of this are the wealthy – 90% of capital gains made are over £100,000, and 60% over £1 million.
Aligning the taxation of income from work and wealth has a history of broad support. Nigel Lawson first equalised the tax rates on earnings and capital gains in 1988, declaring: “In principle, there is little economic difference between income and capital gains, and many people effectively have the option of choosing to a significant extent which to receive. And in so far as there is a difference, it is by no means clear why one should be taxed more heavily than the other.” The systems remained aligned until the Brown reforms of 2008. And when George Osborne raised the top capital gains tax rate to 28% in 2010 he argued: “Some of the richest people in this country have been able to pay less tax than the people who clean for them. That is not fair.” (He later lowered it again, to 20 per cent for most assets.)
It’s also more economically efficient. All taxes create economic distortions and inefficiencies, but spreading the burden of taxation more evenly across the economy allows the Chancellor to raise revenue with the minimum of economic cost.
It removes the opportunity for tax avoidance. Capital gains tax was originally created in 1965 not to raise revenue, but to act as a critical backstop for the income tax system. Bringing the rates closer together prevents wily investors from shifting their income from earnings to capital gains to reduce their overall tax burden. Estimates from the 2010 Budget imply that every one percentage point difference between the top rate of capital gains tax and the higher rate of income tax costs about £75 million a year in lost tax revenue.
Our current system is wasteful. It’s vital to encourage the investment, innovation and dynamism that we need. But giving a tax break to capital gains across the board – to the tune of £20 billion a year – is a very expensive way of doing so. Across the developed world, markets are becoming less competitive and more dominated by large firms with monopoly power. And huge sums have been accumulated in the form of rising land values via the property market.
These are examples of rent-seeking – activities that enrich one party at the expense of another, but make little difference to our collective economic wellbeing. We want to encourage not capital gains on assets in winner-takes-all markets but capital gains on the firms and investments which genuinely make us all better off. There are much better ways to spend £20bn to encourage investment – from basic R&D, to education, to lending to innovative SMEs.
What about encouraging risk-taking? While encouraging productive risk-taking is desirable, it’s also legitimate to recognise the contribution that public investment makes to a new venture’s success. For example, private investment has in the past built on public investment in blue skies research. And financial sector bailouts mean that some of the downside from private risk-taking is borne by the public. Taxing some of the capital gain allows the public purse to recoup some of its investment.
Finally, ending the favourable taxation of income from wealth is the right thing to do. If we want a meritocratic society where everyone has the chance to work hard and get ahead, then we cannot place a heavier burden of taxation on those who are working hard than on those who are lucky enough to inherit wealth, or to be able to buy multiple properties at the beginning of a boom. Currently we make it easier for the rich to get richer than for the poor to catch up. The wealth of a child’s parents is an increasingly important determinant of their life chances. This is neither right, nor sustainable. Instead, we must make sure that work pays, and that everyone has a fair chance to build up their own savings and gain a stake in the economy.
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