The Lib Dems should scrap their plans for a rise in this dishonest tax

Should capital gains tax (CGT) be higher? The Lib Dems certainly think so. One of the key planks of their economic policy involves preventing people from easily multiplying their wealth.

So, they want a mansion tax – although even Nick Clegg now admits that the plan is a bit “crude” and a higher Council Tax might be a better idea (as we have suggested several times in the past).

They want to cut the relief higher-rate payers get on pension savings (probably to 30%). And they want to cut the CGT allowance from its current £10,600 to £2,000, while shifting the rate at which it is paid to your marginal income tax rate or to a flat rate of 35% (it was the former, but David Laws suggested on the BBC today that it is now the latter).

I don’t like the mansion tax, and I’m not entirely happy with the pension change (it would be incredibly complicated to implement), but I think the rise in CGT is a real shocker. To see why, you can read my longer column on the matter from some months ago.

The key point is that the modern CGT does not account for inflation. So let’s say you bought a holiday house in Cornwall in the 1970s for £10,000, and it is now worth £200,000. Sell and you have a nominal gain of £190,000.

Before Gordon Brown’s changes to the CGT system you would have paid capital gains tax only on the non-inflationary part of the gains – ie, the real addition to your wealth from the ownership and sale of the asset. In this case, £10,000 in 1975 is the equivalent of about £90,000 today. That would have made the taxable gains £110,000.

The rate then was 40% and the tax bill £44,000. Under today’s rules, you would pay tax on the entire nominal gain at 28% – so £53,200*. And under the Lib Dem plan of charging you 35% on the entire nominal gain, you would pay £66,500.

In the case of the holiday cottage, you are still up on the deal in real terms – you have more purchasing power than you had before (assuming you don’t want to buy another house, of course). But that’s only because the gains on property have outpaced general inflation so hugely. Look at other assets, and it isn’t so much the case.

The point here is that the name of the tax suggests you are being taxed on an actual gain, but you are in fact being taxed on a nominal gain. That makes capital gains a very high stealth wealth tax. And a deeply dishonest one at that. 

* I’m assuming no CGT allowances here for simplicity, but clearly, if you add in the reduction in the allowance under the Lib Dem plans, it is all rather worse.