Rachel Reeves may be preparing to go further on capital gains tax (CGT) in the Budget, with experts warning that any increase would hit a wide range of investors, not just the wealthy.
As the chancellor searches for new revenue sources, she “may be tempted to engage in a more full-blooded attack on asset gains”, according to Laith Khalaf, head of investment analysis at AJ Bell.
“Equalising capital gains tax rates with income tax rates has been widely touted for a while and may lead the Office for Budget Responsibility to forecast a few extra quid coming into the Treasury as asset prices rise,” he said.
Reeves increased CGT rates in her first Budget, but the fiscal outlook has since deteriorated, with pressure mounting on the Treasury to plug gaps left by soft growth and higher borrowing costs. Khalaf said this could make another rise more likely – even if it carries long-term risks.
“By announcing the tax ahead of its implementation, the chancellor can almost certainly boost short-term tax receipts as investors crystallise gains before higher rates of tax come in,” he said. “However, there is some doubt over whether raising capital gains tax is good for tax revenues in the long term.”
Higher rates tend to change investor behaviour rather than raise sustainable income, encouraging more people to shift money to vehicles that exempt, like ISAs, gilts and primary residences.
“It also discourages entrepreneurship and investment in productive assets – something which cuts across the chancellor’s plans to boost economic growth and the UK stock market,” Khalaf added.
He also warned of unintended demographic effects. Since capital gains tax does not currently apply on inheritance, higher rates could prompt older investors to hold onto assets longer rather than sell them, in order to pass them on.
“Of course, it’s possible Reeves might choose to close that loophole too,” he added. “But after increasing inheritance tax on pensions and farms, that might be a death tax too far.”
Sarah Coles, head of personal finance at Hargreaves Lansdown, said that for many investors, further CGT hikes would add to an already punishing few years of tightening tax rules, “adding insult to injury” for investors who have already had to deal with the dramatic cuts to the tax-free allowance and a hike to the rate on stocks and shares.
The shrinking allowance also means even middle-income savers can now be caught.
“This isn’t just a tax for the mega wealthy. Someone on an average income who has invested carefully throughout their life can easily face a tax bill when they rebalance their portfolio or sell up to cover their costs later in life,” she said.
“In fact, cutting the allowance has hit smaller investors harder, because it used to cover a much larger proportion of their gains.”
What investors can do
There are several strategies to limit exposure, but Coles warned that these depend on current rules that may not stay unchanged.
She suggested using the annual allowance of £3,000 to realise gains gradually over the years or the Share Exchange process to move assets into a stocks and shares ISA.
“You can also offset any losses against your gains or give assets to a spouse or civil partner so they can use their annual allowance too.”
Holding assets until death remains one way to avoid paying CGT altogether, since gains currently reset to zero. “It just remains to be seen whether this will remain the case after the Budget,” Coles said.