What does a Labour government mean for the future of CGT?

10 July 2024

It is no surprise that capital gains tax (CGT) is the subject of rumour and speculation as its rules have been regularly tinkered with by chancellors in the past. We look at some of the historical changes to highlight what we might expect in the future.

During the 1980s, the Conservative government recognised that much of the yield from CGT arose from inflationary gains and introduced changes to target the tax on real gains, in particular the introduction of the ‘indexation allowance’. Given the headlines relating to the UK’s inflation levels over the past few years, this may sound familiar. The current rate of inflation is hovering around 2%, which is very different to the highs of 15-25% seen in the 1970-80s, but inflation has only recently fallen to those levels and we have seen big jumps in asset prices in recent years. 

Any move to align CGT rates with income tax rates could well result in indexation allowance being dusted off and it, or a variation of the rules, being reintroduced. The question then left on some taxpayers’ minds is what will happen to the rate of CGT? 

Once the matter of inflationary influence on CGT has been stripped away, there are at least two concerns for government to address: that CGT should not disincentivise long term investment and entrepreneurship; and that the tax should not distort individuals’ behaviour to the extent they seek to avoid income tax by converting their earnings into capital. The CGT rate is a tool in the government’s toolbox to balance these concerns, yet there has arguably been limited success to date. 

If there is little economic difference between income and capital gains, there may no longer be a strong case for taxing one more heavily than another. This was the argument made in 1988 when the Conservative government aligned CGT rates with income tax rates. Headline tax rates remained aligned for 20 years.

In the late 1990s, the Labour government’s priority shifted to use CGT to encourage investment and reward longer-term ownership with the introduction of ‘taper relief’. However, in 2007, it sought to significantly simplify the CGT system. Taper relief was ushered towards the exit and in its place came the announcement of a flat rate of CGT at 18%, followed by the introduction of a new 10% Entrepreneurs’ Relief rate. This broke the longstanding link between CGT and income tax rates.

However, concerns grew about the structure of the CGT regime and it highlighted the disparity of potential tax outcomes for wealthy individuals utilising lower CGT rates. Following the financial crisis, an increase in CGT rates was a key concession given by the Conservatives to the Liberal Democrats in forming the 2010 coalition government as it helped demonstrate that the pain of dealing with the fiscal deficit was being spread. 

As a result, a new 28% CGT rate for higher rate taxpayers was introduced. Then in a later attempt to reward entrepreneurial investment, in 2016 the Conservative government announced new lower rates of CGT at 10% for basic rate taxpayers and 20% for higher rate taxpayers. Cutting the rates was intended to support companies in accessing capital through reinvestment. Around the same time, CGT surcharges were introduced for residential property gains and gains on carried interest.

Historically, many changes to CGT have applied from the start of the following tax year on 6 April, with some announced with six months or less notice until the date the changes become effective. However, in recent years the government has increasingly announced tax changes with immediate effect as part of the Budget or other fiscal events. In addition, business owners will remember in particular the immediate and retrospective changes that were announced to the Entrepreneurs’ Relief limit in March 2020. 

Many believe under the new Labour government that CGT rate increases are a question of when, not if, as a result of a need to raise tax revenues if economic growth is not delivered quickly enough. Labour’s election manifesto pledges to increase investment and history shows CGT is a key lever in promoting investment and growth. Precedent suggests that any changes to CGT rates may be quickly implemented. Investors should consider their investment strategy with this in mind.