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Capital gains tax raid could create one of the world’s most ‘anti-growth’ tax systems

October 21, 2024

Labour’s non-dom tax reforms could cost the UK £1bn as wealthy individuals leave, warns Oxford Economics, citing concerns over inheritance tax changes and reduced investments.

Chancellor Rachel Reeves’s upcoming Budget risks pushing the UK towards having one of the least competitive tax systems in the developed world, according to a major new analysis by the US-based Tax Foundation and the UK’s Centre for Policy Studies (CPS).

The report warns that if Labour introduces a widely expected capital gains tax increase, the UK could plummet further down the Organisation for Economic Co-operation and Development (OECD) tax competitiveness rankings.

The UK has already dropped to 30th place out of 38 OECD countries in the Tax Foundation’s 2024 International Tax Competitiveness Index, as a result of the previous government’s measures. However, the study suggests that further tax hikes under Ms Reeves could see Britain fall another four to five places, leaving it just ahead of France, Italy, and Colombia in the overall rankings.

Daniel Herring, a researcher at the CPS, warned: “There’s a real danger that Britain could end up with one of the least competitive and most anti-growth tax systems in the OECD if the expected tax rises come to fruition in the Budget. If Labour truly wants long-term economic growth, it needs to consider fundamental tax reform, rather than just increasing taxes.”

Concerns over capital gains and dividend tax hikes

The analysis focuses particularly on potential increases in capital gains tax and dividend tax. The CPS modelled the impact of these measures, showing that raising capital gains tax could drop the UK’s ranking to between 32nd and 34th. Similarly, raising the higher rate of dividend tax to 45%, to align with income tax, would drop the UK two places to 32nd. If both changes are combined with a mooted wealth tax, the UK could fall to 35th place, fourth from the bottom of the OECD rankings.

These changes are being considered as part of Ms Reeves’s broader tax reform agenda, which aims to raise £35 billion in new revenue. While a wealth tax has reportedly been ruled out, tougher measures on capital gains tax and inheritance tax appear likely. The Chancellor is said to be reviewing business and agricultural reliefs offered under inheritance tax, which currently grant 50% relief on the value of property and land.

Threat of a brain drain and market destabilisation

Wealth advisors are warning that the proposed tax changes could lead to a “brain drain” as business owners consider relocating abroad to avoid punitive taxes. Jason Hollands, managing director of Evelyn Partners, highlighted that many entrepreneurs are already exploring options to become non-residents if the UK’s tax environment becomes too hostile.

“There is a risk that we end up exporting many of our entrepreneurs overseas, sapping the economy of job creators,” said Hollands. He noted that his firm is already having numerous conversations with clients who are researching the possibility of leaving the UK in response to potential tax hikes.

In addition to the potential exodus of entrepreneurs, analysts have raised concerns that changes to inheritance tax reliefs, particularly on Aim-listed stocks, could destabilise investment markets. Mr Hollands pointed out that removing Aim’s business relief could have a significant impact on the market, as a large portion of Aim investments are tied to tax mitigation strategies. He warned that removing business relief without transitional arrangements could prompt a wave of sell-offs, further weakening the exchange.

“Aim has already been struggling with a dearth of IPOs and a reduction in the number of companies listed. Removing business relief would be a real hammer blow, especially if existing shareholders are given no incentives to hold on,” Hollands said.

Mixed messages on pro-growth agenda

The potential tax increases come at a time when the government is promoting itself as pro-growth. A Treasury spokesperson pointed to the record £63 billion of private investment secured at the recent International Investment Summit as proof that the UK remains a top destination for business investment. They added that Ms Reeves’s budget would continue to support businesses by capping corporation tax at 25% and publishing a business tax roadmap to provide long-term certainty for businesses.

However, mid-sized businesses remain concerned about the impact of the Budget. A recent survey by accounting firm BDO found that many of the 500 businesses surveyed were worried about rising costs and a lack of clarity on government policy. Richard Austin, a partner at BDO, said: “These businesses are crying out for some certainty.”

As the UK government walks a fine line between increasing revenue and maintaining competitiveness, the upcoming Budget will be crucial in determining whether Britain can balance its growth ambitions with a tax system that supports businesses and entrepreneurs.