The state sponsored theft you just can’t escape

I spoke to a friend in his seventies a few weeks ago who told me that he was frightened to pass too much of his wealth on to his children. Why? Because with inflation at 3-4% and likely to keep rising from here, he was worried that his investments were likely to lose purchasing power – and that he would need a much larger nominal sum to keep going than he had hoped.

He’s right to be worried. Our inflation problem hasn’t gone away. You can argue forever about whether quantitative easing (QE) causes domestic inflation or not, but what is absolutely clear is that it pushes down the value of sterling and so imports inflation: every time Mervyn King opens his mouth to talk down the pound the price of everything you buy from abroad goes up again.

How high will our annual price rises go from here? It is hard to say, but given ongoing QE here and everywhere else, I think I would have to agree with Alistair Darling who told a City dinner this week that it is soon likely to be “quite a big problem”.

So what can my worried friend do to protect himself? The financial industry, as ever, is not exactly short of solutions. You should buy equity income funds, they say. Look over the very long term and you will see that pretty much regardless of the starting point you choose, shares, representing as they do small slices of real assets, have protected investors from inflation.

You can buy property. It hasn’t been ‘all that’ in the last few years, and is still grossly overpriced by most historical measures, but if inflation really takes off, it should provide some small measure of protection.

You can buy other real assets and hope that they rise in nominal price, if not in real value as the Consumer Price Index rises.

And finally, of course, you can make sure that your assets are well diversified outside the UK – that way, however much the pound falls you will be covered by the corresponding rise in the other currencies you are effectively holding. That makes sense, because even while we pay our bills in sterling, a huge percentage of them are actually priced in foreign currencies anyway (energy and food, for example).
 
By now you will be thinking that this is all terribly straightforward. You just buy a couple of the asset classes I have mentioned above, and your work is done. Sadly, it isn’t so.

I have bad news for you. It is practically impossible in the UK for an investor with any real wealth to outrun inflation, whatever he buys. I repeat, whatever he buys. Why? Capital gains tax.

Imagine that you buy some gold, some gold shares or perhaps a gold ETF for £20,000. Over the next ten years, inflation averages 8% a year. Your gold does just as you hoped. It also rises in price at 8% a year. So the gold is worth £43,200. And £43,200, it now has the same purchasing power as £20,000 in 2013.

So in 2023 you sell it. You get £43,200. But you also get a capital gains tax bill. You’ve made a capital gain of £23,200 on which you will pay 18% or 28% (mostly 28%, given the way the bands are calculated) over the annual allowance.

You could assume that the allowance goes up with inflation. But as I think we all know, that isn’t going to happen (hello, fiscal drag), let’s assume it rises at half the rate of inflation in question. It’s now £10,600. So we can guess it at something like £16,000. So you pay CGT on £7,200, and you end up with £38,016.

Thanks to the fact that UK CGT is no longer indexed to inflation (it was until 2008) you have lost purchasing power regardless of your excellent investment choices. The key point here, however, is that the more money you have, the more purchasing power you are going to lose (unless you are cheating on your taxes, of course).

Let’s say you buy £200,000 worth of gold in the first place. Now you have £432,000. But you have no allowance left and you have to pay 28% on £232,000. You end up with £367,040. Your purchasing power – the value of your wealth – has just fallen by 8.5%. Make inflation 12% and you will find that on the same initial investment you end up nearly 20% down in inflation-adjusted terms after tax.

The point? Non indexed capital gains tax is effectively a wealth tax: the more inflation rises, the poorer UK investors will get. That’s regardless of how well they invest. 

There are a few things you can do to mitigate this state-sponsored scam, of course. You can invest as far as it is possible via your ISA and SIPP. You can incur return-gobbling expenses every year in order to use up your CGT allowance. You can visit a dodgy accountant to try and create some tax losses to set against your gains (although the odds are a visit from HMRC will soon follow this). And of course you can buy an asset that comes free of capital gains tax.

You might buy a bigger primary residence (the lack of CGT on these is the primary reason why rich Brits are so obsessed with property). You could also buy a vintage car (these are classified as wasting assets and so are exempt) or some index linked bonds. And finally, you could buy gold sovereigns or Britannias (which are legal tender, and so CGT exempt) although they already trade at a hefty premium to the physical gold price. But that’s about it.

So there you go. Unless something dramatic changes in our tax system, it is not really possible for the well off to prevent the state, via a combination of tax and loose monetary policy, relieving them of a large percentage of their wealth as inflation picks up. Sorry.

• A version of this article was first published in the Financial Times

34 Responses

  1. 04/03/2013, Segedunum wrote

    t if it ends up being a worry for most people expect trouble.

    Yes, I know Britannias and Sovereigns are supposedly CGT free at the moment if you’re looking at precious metals, but that will disappear as soon as the government starts getting really desperate for income.

    The government is just making a very large rod for their own back here and I see a great deal of trouble in the coming years.

  2. 04/03/2013, David wrote

    I heard in the press that the Labour party will soon be releasing a report saying GCT should be reduced for assets held over the long term. A good article. Agree that CGT destroys wealth, and so takes away the best efforts of people trying to beco,me self-reliant. This Tory government is definitely against self-reliance, thrift and aspiration.

    On your negative rates article (can’t comment on page) – well done for standing up against this crazy idea. Of course, we already have negative “real” rates of interest, and have had them since the 2007-8 crisis.

  3. 04/03/2013, Concerned of Teddington wrote

    One alternative, which I’m -not- suggesting is … catch a flight to somewhere like Singapore [insert alternative], pop into a branch of UOB [insert alternative] and open up a savings account for your child(ren) These may off term deposits or stocks etc… Then pay into that. The account is in the name of your child – of course you don’t tell your children you are doing that – to stop them spending it all when they reach 16 or 18 or whatever…. Rather have something on-line that can be ‘unlocked/sent’ in the event of death or you not performing some action regularly – they then have an overseas account and its up to them to declare it to the tax authorities. Helps if you have a passport for more than one country.

    Probably simpler to just emigrate to some country that is slight less of a basket case.

  4. 04/03/2013, Boris MacDonut wrote

    #2 David. CGT was brought in by Harold Wilson in 1965 to counter the all pervading tax dodging of the rich,who no longer wished to contribute towards a better future.
    Merryn. Did you just suggest everyone buy a bigger PPR? I thought MW was convinced porperty prices would tank by at least a half.

  5. 05/03/2013, Aff wrote

    Gold sovereigns are exempt from CGT. Buy those

  6. 05/03/2013, DrGrumpy wrote

    Can anyone give me a definitive answer to the question whether UK silver coins such as britannias are exempt from capital gains tax? Are they also legal tender, and is is the criteria for tax exemption? Everyone gives me a different answer.

  7. 05/03/2013, GPS MacPherson wrote

    #2 David. Interesting if true, as sounds a lot like “taper relief” which the then Labour government abolished in 2008 in a knee-jerk reaction to stories about how PE was able to use this to shelter gains made (if my memory serves me correctly). Somewhat ironically, it was an earlier Labour administration which introduced taper relief in the first place, around 1998, to replace indexation relief on capital gains…

  8. 05/03/2013, Rick62 wrote

    CGT is also freezing up potential investment, leaving money in legacy investments rather than redirecting to new opportunities.

    I invest modestly in young companies. I might see a company and be minded to invest, helping grow that company. To free up the capital I could sell some of my Lloyds Pref shares, currently £1.20 and yielding income of 9.25%. However after CGT, spread, fees etc I would only receive about £1.00. To give up the safe income (and with additional income tax of only 25% versus CGT of 28%) to lose a big chunk in CGT to invest in a more risky young company, it doesn’t add up, I’ll keep taking my regular safe income.

    You might say I’m very lucky to be in a position to worry about CGT, however it is people like me, that have built up some wealth by taking huge risks and building successful businesses in the past that are needed to help businesses get going and create the future companies that we all rely upon for jobs and taxes.

  9. 05/03/2013, Graham Wadsworth wrote

    Regarding Concerned of Teddington. Why go to the trouble of going to Singapore? If you have reached the age when inheritance tax is starting to loom large in your mind, presumably your children have reached a mature age themselves. So, why not, with their agreement, open an ISA in their names and they ‘give’ you the interest. It does not affect their tax status and when you die, the money is already in the hands of your children. But what if they chose to spend the money? Well as someone once said, inheritance tax is for people who trust HMRC more than they trust their children.

  10. 05/03/2013, Changing Man wrote

    Unless you are earning shed- loads of cash surely there are many ways of avoiding CGT? ISAs at £11k pa, pensions @ £50k pa, treasury loan stock, premium bonds and national savings certificates, foreign currency for personal use abroad, any amount in your own home and personal possessions eg jewellery, paintings, or antiques up to £6k each. Your car is also excluded. Maclaren F1 perhaps?
    If you still have a CGT liability after that lot then you can probably afford to pay someone to lose it for you?

  11. 05/03/2013, uncommercial wrote

    This article takes a very extreme view. CGT is in reality unfairly low. It also does not apply on death, nor does it apply to investments inside either a pension fund or an ISA. Anyone who has money dedicated to investment can shift over £10K per year into an ISA and over £3K into a pension. If that’s not enough for you, stop bleating! Ideally, capital gains would be indexed but then taxed as income. Why not? And if tax is theft, then presumably being getting treatment without paying in your NHS hospital is likewise theft.

  12. 05/03/2013, Evilbungle wrote

    @11 If you think that you don’t pay for NHS treatment then i can only assume you are not working/saving or purchasing goods. I can assure you that every tax payer in this country pays many times over the odds for the treatment they recieve in the NHS. Is it theft? it depends, I have money taken from me by threat of force and in return recieve the promise that if I am injured or ill I will get, often second rate, treatment. It may not be theft but it certainly isn’t a deal I would make.

  13. 05/03/2013, Hardwin Tibbs wrote

    I agree with your comments on CGT. It was the Lib Dems who forced the increase to 28%. Last year, at Prime Minister’s Question Time, David Cameron actually boasted that the Coalition had increased CGT which is a little suprising for a Tory!

    The end result is that tax income from CGT has probably reduced. Unfortunately we have a Government who want to screw anybody who has accumulated a bit of money.

  14. 05/03/2013, toetag wrote

    @DrGrumpy, Legal UK tender is CGT free, however silver does attract VAT. So you end up 20% down before you start!

  15. 05/03/2013, JREwing wrote

    This is, unfortunately, the truth. The current policies are going to ruin not just the rich but the whole country. On a recent trip to the UK, I started to get that distinct “third world” feel. This is a little unfair. The country isn’t quite there yet. But the trains were overcrowded (on a Saturday night I might add) to the point of looking like a commuter train in Mumbai, the constant rattling, the inordinate amount of time it takes to get from Heathrow to the City (and back) etc – I felt satisfied that I wasn’t living in Britain any more. I am sure if you asked other expats they would say the exact same thing.

    It is amazing how modern academics who feed off the public trough have managed to convince everyone that borrowing to consume guarantees a richer future. Were that the case, the country that built no new factories and lived entirely on imports would be the richest on earth. But it doesn’t work that way.

  16. 05/03/2013, Peter Kellow wrote

    Capital gains is income. What on earth would it not be taxed? And as uncommercial says why not at the same rate as other income?

    I have made the same comment myriad times but if you are rich enough to have assets to dispose of then it is unlikely you will use that money to buy CPI items, i.e. shopping basket stuff. You are more likely to buy other assets whose value swings have no relation to CPI. The maths in this article is totally distorting because it ignores this simple fact.

    This article sound all too much like well-off people carping about paying tax when the taxes are too low anyway. And Rick62’s argument about his not being able to do venture capital sounds like special pleading.

    The reason why in general taxes are too high in the UK is because big companies pay hardly any by using tax havens. For how long are honest investors going to stand for that?

  17. 05/03/2013, JREwing wrote

    @ Peter Kellow – “Capital gains is income.”

    No it isn’t. You do not run a risk of loss when you receive income from an employer. You do when you buy shares or any other investment.

    The rest of your comments are of the same standard as the above.

  18. 05/03/2013, Rick62 wrote

    Peter, I’m not special pleading, I’m pointing out that it is now a better risk reward for me to leave my investment in legacy mature income producing investments rather than to redirect into other younger more dynamic businesses.

    Either way I’m fine, I don’t need any special consideration, but I’m now less likely to support young growth potential businesses than I was.

    Also on income, being franked, I only pay a further 25% while if the business retains the cash to grow and produce capital gains then I pay 28%, a higher tax on a higher risk investment stratergy. This can only damage the ability of young companies, needing cash, to raise investment.

  19. 05/03/2013, Peter Kellow wrote

    @JREwing

    If you loose on some shares you will offset this on gains on others and there is plenty of scope for transferring losses between years

    When you are employed you make a big life commitment. If you loose your job your life can be ruined.

    The point is choosing shares and choosing a job both carry risks. The big difference is that you can spread choice of shares but taking on a job is single one off commitment that can go bad

    “The rest of your comments are of the same standard as the above.” is not an argument. I presume if we had the benefit of your comments on my other points they would be of the same standard of ignorance as the comment you did make.

    No wonder you hide your identity

  20. 05/03/2013, Peter Kellow wrote

    @Rick62

    The reason why I said ‘special pleading’ is that you cannot expect the tax regime to be organised around venture capital of the type you provide

    Don’t get me wrong, I am full of admiration for ‘angels’. But the fact is the amount of new investment that comes from them is tiny.

    If you don’t like the amount of tax you pay, then have a go at tax avoidance/evasion through offshore jurisdictions. That is where the real losses are

  21. 05/03/2013, Tom O'Neill wrote

    This was all predictable, and is precisely the reason why everyone should be investing the maximum annual allowance in an equity ISA. I’ve been doing this since the PEP scheme started, and have a large income from shares, prefs and bonds which the taxman cannot touch – no income tax, no CGT. Investments include gold shares, ETFs, and smaller company growth shares. Selling attracts no tax. Outside the ISA I keep within the annual maximum income and share sales. It’s not difficult.
    I expect a day will come when the ISA tax-free protection wrapper will be ripped away ‘in the national economic interest’, and presumably at the same time export controls will be imposed – something that, ironically, leaving the EU would enable the government to do.

  22. 05/03/2013, GFL wrote

    It is very difficult for an ordinary middle class family to move into the ‘well off’ category with investments and PAYE salaries alone, even if they are reasonably well paid and invest wisely.

    Investment bankers, CEO’s and celebrities aside, pretty much the only away for employees to get ahead is by leveraging their money, hence the UK (in fact a lot of the western world) is obsessed with property – people don’t mind paying tax as much on money that wasn’t theirs in the first place. Property is the easiest way for the average Joe to gain access to credit (credit, not money, makes the world go round!)

    Those that don’t fancy the hassle/risk of BTL, ploughed all their savings into the most expensive property they can (or cannot) afford, since the capital appreciation is considered tax free income. Happy days!

    This obviously has some really nasty unintended consequences, which we are starting to realize and will continue to do so for another 15ish years.

  23. 05/03/2013, Despondent wrote

    Good debate, folks! One of the main snags with CGT is that it is only levied at time of sale. If the asset has been held and appreciated in value of several years, why won’t HMRC let you spread the gain over all those years? If you were able to B+B assets every tax year the problem goes away, but think of the fees that some grasping paper handler would get! No one ever said that life had to be fair, but lots of dosh helps.

  24. 05/03/2013, Clive wrote

    @ Peter Kellow

    I can see why you might say “Capital gains is income. What on earth would it not be taxed?”.

    Does that mean you’re in favour of taxing the gain when a primary/only residence is sold ?

    After all, it IS a capital gain which you then classify as income.

  25. 05/03/2013, Tom O'Neill wrote

    Now that we have computer programs that can calculate everything under the sun instantly, it would be perfectly possible to apply a sliding scale to income tax and CGT, instead of hammering anyone who inadvertently peeps above the thresholds/bands.
    But then the Treasury wouldn’t be able to afford three-course lunches at the Caprice.

  26. 05/03/2013, Peter Kellow wrote

    @Clive

    The reason why primary residences are except from CGT is to allow people to move fairly easily for job or other reasons and this should remain

    Interestingly as prices fall people might start to wish their houses were subject to CGT then they could offset that loss against gains elsewhere. But then people could learn from our fine MPs and shift their primary residences around.

  27. 05/03/2013, Clive wrote

    @ Peter Kellow

    I’ve got some money in the markets and am just getting to the point where I have to worry about hitting the CGT limit when moving investments.

    I can see the argument of taxing share gains as income, at least when you’re not investing in a business you own.

    Governments always say “we could make money off XYZ, let’s up the taxes”. They don’t concern themselves with how people will react.

    What I guess would happen would be you’d see less investment in the markets and the money would flood elsewhere. E.g. I was reading in the paper on the weekend how arable farm land was free (I think) of IHT. Might find that suddenly attracted a lot more money and, once again, the government wouldn’t get the easy win they expected.

  28. 05/03/2013, Hardwin Tibbs wrote

    The point about CGT is that it’s voluntary. If I don’t sell I don’t pay tax.

    Last year I tried buy a small factory unit from my landlord. Unfortunately he wouldn’t sell because he didn’t want to pay tax at 28%.

    I own a small holiday home which I would like to sell but I’ve decided to keep it and rent it out for the same reason. A few years ago CGT was 40% but you could apply taper relief. Now it’s 28% flat so I would be worse off!

    As I said in a previous post, I would guess CGT income has come down in the past two years.

  29. 05/03/2013, Peter Kellow wrote

    @ Clive

    Well, there is always the law of unintended consequences. If money ‘floods’ anywhere that will create a bubble and people will want to get out again.

    You have to look at everything in the round. The two big things that push up the taxes that are collected are (1) taxes not collected due to tax havens and (2) the way the government raises money through bond issues

    I favour government shares not bonds, developing national savings, and printing money for government investment which will later show a return in taxes collected, e.g education

    Taxes could then be evenly spread across, CGT, income tax and Corporation tax, but overall a lot lower

  30. 05/03/2013, Sidney Rough Diamond wrote

    Merryn

    Thanks for another interesting article, many interesting things have come up during this discussion which have given food for thought.

    @ 22 GfL

    I think you are right about ‘unintended consequences’, and I think your 15 year – ish theory will be proved correct.

  31. 05/03/2013, Tired and Grumpy wrote

    Check out HMRC website and their breakdown of receipts for 2011-12: 28% income tax, 21%NIC, 21%VAT, 9% Corporation Tax, <1% CGT! Actually CGT down by a half since indexing abolished. Conclusion 1 = the workers are being screwed. Conclusion 2 = No CGT indexation is a tax on Government generated inflation. Conclusion 3 = CGT could be index linked or abolished with no overall negative effect and may even liberate capital to generate economic activity instead of being ‘frozen’ in assets. Conclusion 4 = maybe time to emigrate?

  32. 06/03/2013, Evilbungle wrote

    The issue with thinking about gains as Income is that the money I spend on investments is already taxed at source, So why should it be taxed again?

    I think it is easy to think of CGT as a tax on “additional earnings” but for many people the money invested is invested to provide a retirement income. When I retire I will be selling my investments to hopefully keep myself in a comfortable position. with CGT I need to invest 28% more to cover the taxes I will need to pay. As I have already lost 20% of my income as Incoime Tax and 12% as National Insurance it means that I need to earn twice the money I need just to stand a chance of being able (At some point in many years time) to not have to work. So once again we destroy aspiration.

  33. 06/03/2013, Evilbungle wrote

    And responding to a comment above I do not think the reason we are taxed so heavily is because corporations do not pay their taxes but due to the fact that the government spend far too much money, after all if companies paid more tax it would put prices up which would raise inflation which would make the issue of CGT even worse. After all we already have a 20% uplift on the cost of all our goods as it is.

  34. 07/03/2013, James wrote

    A bit slow posting this but, re the original point of the article (The state sponsored theft you just can’t escape) and building on #3 concerned of teddington. The issue is being taxed on inflationary gains, with Merryn also mentioning UK’s QE, generally seen to weaken GBP and a history of higher UK inflation and currency depreciation than eg Germany or US. So, if you deposit your money in eg Sing dollars (which you can do without leaving the UK, no need to fly anywhere) you can be expected to gain from the currency movement. This is CGT free when you convert back to GBP (not sure if this treatment is per the statute book or an HMRC concession). The interest income is taxable for UK residents as normal. The only issue with this is you have to leave the money in cash. If you buy a (non PPR) property, the entire gain including any FX gain is liable to CGT.

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