Happy Budget Day! Depending when you’re reading this then Rachel Reeves is either about to deliver her first Budget as Chancellor of the Exchequer or has already done so. It’s been heavily rumoured that she intends to hike Capital Gains Tax (CGT) and/or restrict Business Asset Disposal Relief (BADR). This would be a mistake.
I want to start by saying that I fully accept that it is not fair that we tax people who get their money from working for a living differently from people who get their money from assets. The current tax system does have a distortionary effect and so this is less ideal. However, equalising CGT with Income Tax and/or restricting BADR would have a number of negative consequences which means that the government should resist the temptation of doing it.
Labour has got themselves into a bit of a bind over what they mean by ‘working people’. While it is true that people who derive income through rent seeking activities such as landlords are not ‘working people’ and lots of people whose income is derived entirely from assets are certainly not struggling to make ends meet and so it would be wrong to view them as a ‘working person’, it does not necessarily follow that someone who gets at least some of their income from assets is not a ‘working person’.
I’m thinking here of entrepreneurs who cannot afford to yet pay themselves a salary (although in many cases they probably have accrued enough savings from earlier work). I’m also thinking of young people who have gone to work for a startup which probably can’t match the starting salaries of an investment bank or a consultancy firm but can offer their employees shares in the company which have the potential to be worth a lot of money in the future. These are exactly the type of people we should be encouraging to start their own company or work for a new one. They are talented and entrepreneurial and, while there's certainly nothing wrong with going to work for an established organisation (or even the public sector), it is these startups which disrupt industries, create new goods and services, and drive economic growth. The government should be encouraging entrepreneurship, not stifling it through the tax system.
On the topic of entrepreneurship there is a danger that it could result in some of the country’s most exciting small businesses which show enormous potential being badly run and never realising their full potential. This is because a visionary founder who is the perfect person to come up with a new idea and secure some funding to develop it and grow the fledgling company from being just himself to something slightly larger is not necessarily the best person to take that business to the next level. That might be better suited for someone with more experience of scaling small and medium businesses into large ones. Increasing CGT or restricting BADR means that the entrepreneur would be more reluctant to sell their stake to someone else which would mean that this business would never reach its full potential which means the country would lose out on new jobs while HM Treasury loses out on extra revenue.
Moreover, the entrepreneur may have used the profits from the sale of their old startup to help them to found a completely new one. Again, this would be a tragedy for the country as we would be missing out on innovative new products which have the potential to improve all of our lives. We’d all be much poorer as a result.
Increasing CGT could also reduce mergers and acquisitions (M&A) activity in the UK. M&A plays a vitally important role in the functioning of the UK economy but we know that CGT can make M&A a less attractive option with a one percentage point increase in CGT rate decreasing acquisition activity by one per cent annually. Again, the government should be seeking to promote M&A activity, not discouraging it through the tax system.
Finally, it is true that owning assets does tend to be the preserve of the wealthy. This might be an obvious point (they’re wealthy so they have wealth in the form of assets), but the government should be encouraging more people to own assets. In the form of housing then the public obviously needs no encouragement in this area as so many people want to be able to own their own home. Unfortunately the UK’s incredibly restrictive planning system not only props up the wealth of people who are already homeowners but it also prevents many young people from being able to own their own home by increasing house prices.
The government needs to liberalise the planning system so that housing becomes much more affordable and so everyone is able to afford to own their home if they want to. Making housing more affordable would also mean that ordinary ‘working people’ would have more disposable income which they could use to purchase other assets such as shares.
At the moment just under a quarter of people in the UK have invested in the stock market. This is not to be sniffed at but when you compare it to the US where that figure is over 60 per cent then it is actually quite disappointing. Part of this difference is obviously due to the fact that Americans do just tend to have a lot more money than the average Brit, but part of this is also surely cultural. We are less likely to take a risk with our money (often for understandable reasons) but we should not want the government to be encouraging this. It means that entrepreneurs are missing out on the capital they need to launch their business. It means that a recent graduate is missing out on a new job in an exciting new company. It means that the Treasury is missing out on revenue which could be used to fund essential public services. It means that the country is missing out on economic growth. It also means that ordinary people miss out on the opportunity to get early stakes in companies which have the potential to be huge and which could make them very wealthy.
I have a lot of sympathy with those calling for a hike to CGT or for restricting BADR. However, this would be the wrong thing to do.
Other stuff
Yesterday I had a piece in Conservative Home, it was on why the government is right to recognise the need for more investment in the economy and that the Fiscal Rules do not come from on high. However, it needs to remember that it is not ‘free money’, will need to be paid back, and so should not go on a splurge. You can read it here.
Thanks as ever for reading. I’ll no doubt write something else after the Budget. Enjoy the rest of the week!