Capital Gains Tax will not...cannot...be enough.

Rishi Sunak is predicted to borrow £317bn extra in year end 2021 and we cannot predict how bad things are going to get between here and there. He's clearly got to raise a whole load of money from somewhere to plug that gap.

One of the most attractive pots of value for a Chancellor to tax is capital gains. Capital Gains Tax is, at present, a much less burdensome tax than income tax; the rates are lower (about half) and major allowances are available such as Entrepreneur's Relief.

All in all it looks like a beneficial regime when compared to the income tax, which is charged at a higher rate, subject to withholding at source for most people, and in general much easier to enforce. If you were a low paid employee in Leeds or Wigan staring tax increases in the face you wouldn't give a jot about the policy objectives which underpin this difference. It is true that Business Disposal Relief encourages long term investment and small business growth, it is true that long term investment is more likely when capital gains are taxed less, but if you are struggling to pay for meals for your children how important is that really?

So, a few months ago, Rishi Sunak asked the Office of Tax Simplification to review the position on CGT, and they basically came back and said..."doubling CGT would be good. It would go someway to eliminate the perceived injustice of people rich enough to have £12,300 in capital gains pay less tax on capital gains than most people pay on their wages.”

Great...that's simple. Problem solved, we'll just double a tax and collect a load more money. If people sell assets quickly to avoid the tax then CGT at the old rate will be accelerated and, if they hold on, when they eventually pay they will pay at the new rate, the increased revenue will go a long way to pay the Covid bill. Win-Win surely? Historically, though, doubling taxes has never really gone as well as hoped.

So let’s think about this a bit.

Firstly, what is CGT?

CGT is a tax on the gain (or profit) that you make when you buy an asset and then later sell it for a profit. The sale of an asset qualifies for CGT if you make a profit and that asset is something you just buy to use or as an investment, not to resell, like a second home, or an antique, or some shares. CGT is charged when you make a profit on something which is not your trade. Gibraltar, by the way, doesn't have CGT.

How much does it raise in UK?

Putting things in context. The UK's total tax take in 2019 was £634bn. Of which £194bn came from income tax, £5.13bn from inheritance tax and £130.14bn in VAT. CGT amounted to £9.98bn or 1.57% of total revenues, slightly more than tobacco duty and one third of the £27.57bn in fuel duty raised.

How much does he need?

The Office of National Statistics predicts that Mr Sunak will borrow an extra £317bn in year end 2021, on which he has to pay interest. In Q1 2018 the UK debt amounted to £1.78trillion and cost £48bn in interest. Let’s assume that borrowing will peak at £2.2tn; and he's getting the new borrowing at a lower rate than his old borrowing. Given those assumptions we can predict that (very roughly) the total interest bill for year end 2022 will be £55bn, up £7bn on 2018.

How much will a CGT hike raise?

As ever with journalistic pieces about tax it is not entirely clear whether or not the journalist is saying that the proposal will gather an extra £14bn or the entire tax raising potential of CGT will be £14bn after the new proposals are in force. Let's be generous and say they mean Rishi will have an EXTRA £14bn after he doubles CGT rates to bring them in line with income tax. Hardly big potatoes compared to the £317bn he's going to borrow by April. If the Chancellor chooses to pay his extra £7bn in interest and then amortise at a rate of £7bn a year it will take him approximately 25-30 years to pay down the Covid debt accumulated in year end 2021, assuming nothing else happens (and that's a big assumption). With debt to GDP at its worst ratio since 1960 it is unlikely the economy can stand that for long.

What effects will this all have?

The assumption that the Chancellor will raise an extra £14bn is not a solid one.

Let’s imagine you own assets in UK, you are a foreign investor. You hear that CGT will most likely go up. So, what do you do? You sell your asset now, after all, you can afford a substantial drop in the sale price (how much depends on how much gain you have) and still be up on the tax hike. As a foreign investor you are likely to be invested in UK property. So, an already precarious UK property market will come under increased pressure, which will drive down prices, which will reduce the capital gain stored up in the properties. Which will mean that the tax taken from such sales will be less. We don't know whether the OTS have got their prediction right, but in the 49 years I've been alive, UK Treasury predictions on tax revenue have rarely been spot on, and that error is seemingly never in the favour of the public purse.

Doubling any tax will be a massive risk for Rishi. People behave unpredictably when tax rises. A perfectly sensible relief may well amount to a disastrous loophole and as the Chancellor's proposals are not fully formed we cannot tell if they will have anywhere near the effect he's looking for.

Either way, he is not going to solve his debt problem by doubling CGT. He needs bigger guns than that.

What other weapons does he have?

Cut Spending?

This is politically very difficult after a decade of austerity and for a government now reliant on the votes of northerners cutting welfare (which will amount to £191bn in spending in year end 2020) and spending would be particularly tricky. There will be cuts, and Labour will make hay, but it is unlikely (given the increased demands on the welfare state, which will inevitably come from a recession hit economy) that they will be sufficient to end the debt problem on their own.

Tax Rises?

It’s clear that the Chancellor will need to raise taxes. Expect a return of the 45% rate, or possibly even the introduction of some form of wealth tax. VAT looks low compared to some of UK's European partners and a rise to 22% would raise about £13bn on 2019's figures and leave UK well within the acceptable band, but obviously depress activity further.

Expect much tinkering and an avoidance of headline rate changes where possible. This is, after all, a Conservative Chancellor (though he seems to spend money like a 1940s Labour Chancellor) so he will avoid things which spook businesses, but he will also have the unavoidable thoughts about what the real effect of his actions are going to be, not just how they look in the headlines the day after the Budget.

Inflation?

Inflation, whether perceived or otherwise, is a stealth tool he has at his disposal. This seems odd to someone who grew up in the early Thatcher years when inflation was the great bugbear and the money supply was never far from the political class' thoughts.

Think about it like this. Ten years ago wages were lower than they are today. They rise naturally based on the law of supply and demand and other inflationary pressures. As they rise people will naturally move up through the tax bands (because they earn more) and they will pay a greater percentage of their wages in tax. The Chancellor doesn't need to do anything. This is called "bracket creep" by tax experts. It happens naturally and guarantees an increased tax take for the government if they just don't raise tax brackets.

Bracket creep guarantees increased revenues, and couple that with the fact that inflation means that the debt he takes in 2020 will necessarily be worth less in 2030 than it was in 2020, and it sounds like a recipe for an easy win for the Chancellor.

So, where will the inflation come from? Well, as those of us who could loosely be called "Thatcher's Children" will undoubtedly remember, if the supply of money goes up...the value of money goes down. Very simplistically of course. Right now there is a huge money supply, the central banks are pouring money into the economy at an unprecedented rate, quantitative easing, furlough schemes etc etc etc. A lot of that money gets sucked up into the financial system. Ask yourself, how can the stock market be nudging record highs when household consumption in the UK dropped by 23% in Q2 and a GDP drop of 25.6% in the same quarter? Simplistically put, because there is a large amount of money around and that is causing asset price inflation.

The problem with inflation is that it does not just wipe out debt, it wipes out savings as well. If you are a cash saver (as the poorest are) then if real inflation (as opposed to the limited scope retail price index) is running at 2% and the bank interest rate is 0.5% then you have lost 1.5% automatically. If you have assets like houses and stocks (as the rich do) then your assets will rise in line with inflation. The rich stay rich, the poor get poorer.

Inflation is not a magic bullet, it does reduce debt and it can be used to automatically increase the percentage tax take from direct taxes through bracket creep, but it shifts value from those who have cash as the bulk of their assets to those who have assets whose price fluctuates. It is a cheap way to devalue the currency.

The real difference from tax increases is that inflation feels like a force of nature. It is politically much more palatable to have inflation run at 5% (still historically low) than to put up tax by an equivalent amount, and if you restrict your publicly acknowledged measure of inflation to the retail price index you can even pretend that nothing is happening. Until the little old ladies can't pay their rent or buy a gift for their grandchildren, or twenty somethings in relatively high paying jobs can't buy houses; no one will notice. Or so the theory goes.

This kind of stealth inflation has been happening for some time already, since the quantitative easing rounds of the 2000s. House price inflation in the UK has been rampant, financial assets are seemingly defying gravity, and have been for a long time. This is partly a result of the loose monetary policies of the last 10 years. How long the public's patience will last if a new round of asset inflation occurs cannot be predicted, but nothing is forever and a public already locked out of the property market, in a country which has as one of its central myths that it is the "property owning democracy", will not have unlimited patience.

Conclusion

So, what conclusions can be drawn? Firstly, I am really glad this is not on my shoulders. I do not envy a Chancellor who carries this burden. Secondly, it’s very clear that CGT hikes will not come close to solving the problem. Thirdly, none of his tools are politically palatable. We can expect to see a mixed bag, there will be tax hikes, there will be cuts, and there will be inflation, all aimed at being as singly painless as possible but adding up to a very difficult package. As the government support winds down (as it necessarily must) those already weak areas will get weaker, the shift in value from cash to assets will cement the wealth imbalance already baked into the UK's society and politics will undoubtedly become more unpredictable.

Fifteen years ago people used to lament the boredom of political life, when New Labour looked like one nation Tories and the painless centre ground was the battle ground with a backdrop of a growing economy. Now those days are gone and huge volatility has returned (and we haven't even talked about Brexit). It will take more than CGT to fix it.

What can you do to escape this?

I'm afraid that every nation is affected by the same issues, but some nations will be in more trouble than others. Some countries have higher costs than others. Small countries tend to have lower tax burdens because they are doing less. Monaco, Isle of Man, Gibraltar etc. don't have their own armies, navies, satellites, and diplomatic corps to pay for so they will necessarily have a lower requirement for tax revenue.

Relocating to a lower tax jurisdiction will mitigate your tax bill (and take you out of some taxes all together if you move to a jurisdiction with a smaller tax base). However, that relocation must be real. If you hope to be "tax resident" in a jurisdiction without spending the bulk of your life there then, in times of ever increasing anti-avoidance measures and automatic exchange of information, you will most likely receive a shock. Reality and substance are the two greatest tools of a tax planner.

Relocating will not, of course, help you to limit the damage of inflation; if you want to stay in the pound zone you will be at the mercy of the pound's value (similarly the Euro and there you will have the pressure of fiscally loose southern European governments), but a politically stable jurisdiction, like Gibraltar, will go someway to insulate you from the winds of turmoil which will most likely be blowing across the continent.

Countries like Gibraltar will welcome you and here at Hassans we can advise on UK tax residence and what is required to ensure compliance with UK rules. We can analyse which jurisdictions, not just Gibraltar, are most useful for you on a meta level and help you navigate the relocation requirements in Gibraltar, if that is the jurisdiction best suited to you. We are here to help.