A simple tweak for a better tax system

A flat tax is a long way off. But this simple tweak to the existing system is a step in the right direction, says Merryn Somerset Webb.

One thing we all agree on is that our tax system is too complicated and provides too many perverse incentives.

We like the idea of a flat tax, and have written about it many times here. However, the odds of the coalition suddenly announcing either that or our other favourite a location tax are not particularly good.

That means that we need to think less about how the system can be radically changed, and more about how it can be tweaked. A good idea arrives from a reader (John Reeve) in response to my blog of a few weeks ago on how a mix of lower taxes and better enforcement might work.

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The tweak? A cut in the top rate of income tax to 35% and a rise in the rate of capital gains tax to 35%. That hints at the flat tax we all rather fancy, and in the process abolishes the "primary taxation distinction between capital and income, the source of huge complexity and massive tax planning endeavours."

But there's more to it. Reeves suggests that there are then two lower bands for capital gains tax. If an asset is held for two years, the rate falls to 28%; if it is held for five or more years it falls to 20%. This would mean that all assets bought and sold with the short term in mind would effectively be reclassified as providing not capital gains, but trading income, and hence taxed identically to other income while those held for the long term would be considered as now as provided capital gains (or losses).

All this, says Reeves, would provide the incentive to generate the income that is the foundation of our economy, but also create an incentive to hold investment assets for the long term, with all the "ancillary benefits" that brings: "more stable wealth creation and greater attention to ownership and governance issues" being the key ones.

You can argue with the rates here; I think that 20% is still too high (there is evidence here that a high rate of CGT lowers revenues) and I am certain that capital gains taxes should always come with inflation compensation built in (otherwise they are not taxes on gains, but taxes on wealth).

But if we want to encourage people to hold their assets for the long rather than the short term, and in the equity markets in particular to engage with the managers of those assets, this wouldn't be a bad way to start.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.