The cruellest tax of all

The latest investment report is out from Troy Asset Management. These have become one of my must-reads and this month’s is no exception. Troy isn’t much impressed with the new round of quantitative easing (QE). It has taken to referring to Mervyn King as ‘Helicopter Merv’ and notes its concern that the Monetary Policy Committee (MPC) appears to be embracing a new policy.

Instead of using QE as a one off “defibrillator-style shock treatment”, the MPC now seems to be looking on it as a “continuous dose of medication.” So much so that we may “look back in years to come and realise that this second round of QE was when the bank began to monetise government debt” – to reduce the country’s debt burden by buying its own bonds with new money.

That makes sense if you look back to 2009 and 2010 and remember that then the MPC promised that QE1 would be reversed at some point in the future: they would sell back into the markets the bonds they had bought and retire the money they had printed. “This time around there was silence.” Are we sleepwalking, asks Troy, “towards further debasement” and eventually far greater levels of inflation, “the cruellest tax of all?” The answer, as I think we all know, is “very probably”.

Troy then notes in passing that, thanks to the fact that our new capital gains tax (CGT) at 28% comes with none of the alleviating indexation or taper relief that it once did, private investors are “more vulnerable than ever to rising nominal prices”. Think about this a bit. There have been endless calls for a wealth tax in the UK over the last year. Vince Cable wants to see a mansion tax and many others want to see either a land tax or a pure wealth tax under which the better off in the country simply have to hand over a share of their assets to the state every year.

But inflation effectively turns CGT into a transactional wealth tax. The less well-off don’t have to pay it – everyone can make £10,600 a year in capital gains with no penalty. But the better-off – or anyone selling a large asset – has to pay it regardless of whether they have made a real gain or not.

Alistair Heath of City AM puts it like this. “Imagine that you owned an asset for the past year that you manage to sell for a 5.6% gain – the rate of retail price index inflation. In real terms, you are not better off; yet you still have to pay a 28% tax on the capital gain above the tax-free threshold. You are paying tax on a meaningless inflationary gain, which means that the tax system has turned into a wealth tax, forcing people to hand over a chunk of their assets rather than a chunk of their gains.”

This isn’t the kind of thing that the authorities like people to notice. And usually they don’t. That’s one of the things that makes inflation such a clever and particularly nasty tax. It is also why Mervyn King, while demanding that we don’t doubt his “determination to meet” his 2% CPI target, doesn’t appear to be under much pressure from George Osborne to do so.