Fixing the £100,000 tax trap would be a bold first step – let’s not undermine it by taxing investment more
Lord O’Neill is right to call for reform of the £100,000 tax trap, but taxing capital gains more heavily could end up costing the Treasury £8bn, says Michael Healy
This week, a group of leading economists led by Lord O’Neill called for a fundamental overhaul of the UK’s tax system. Their argument that Britain has created an overly complex, anti-growth tax system is an understatement of epic proportions. While it was particularly welcome to see reform of the £100,000 tax cliff edge on their agenda, their reported suggestion to bring investment gains closer to income tax rates would be the wrong move. If we want the UK to catch up with countries where investing is far more commonplace, we need a tax system that encourages people to put money to work for the long-term, not one that makes investing less attractive.
Let’s start with where Lord O’Neill is absolutely right. Reform of the £100,000 tax trap is long overdue. This pernicious feature of our tax system has become a real brake on ambition.
Once earnings exceed £100,000, personal allowances begin to disappear, creating an effective marginal tax rate of 60 per cent for many. For families with young children, the loss of childcare support can make the financial hit even more severe.
HMRC expects around 2.06m people to earn more than £100,000 next year, making this far more than a niche issue. Our own research has found people are turning down promotions, refusing bonuses, reducing their hours or increasing pension contributions simply to avoid crossing the threshold. As Jeremy Hunt put it on our podcast this week, it’s “a crazy situation”. There is no doubt that fixing this cliff edge – by tapering the withdrawal of the personal allowance and ensuring thresholds rise with inflation – would support growth, ambition and investment.
Investment is not the same as income
But the same thinking should apply to investment – it isn’t the same as income.
Investors put capital at risk that has already been taxed, often over many years, with no guarantee of making a return. Sometimes investments perform well. Sometimes they lose money. Tax policy has long recognised that difference because investment involves risks that employment income does not.
More importantly, Britain doesn’t have too many people investing. It has too few. At a time when ministers want to boost productivity, support UK businesses and encourage people to build long-term financial resilience, making investing less attractive sends entirely the wrong message.
There is another reason to think carefully before reaching for Capital Gains Tax. IG recently analysed HMRC’s own published behavioural assumptions and found that aligning Capital Gains Tax with income tax rates could actually leave the Treasury almost £8bn worse off each year.
The reason is straightforward. Capital Gains Tax is only paid when an asset is sold. Raise the rate too far and investors delay selling or simply hold on to investments for longer. Fewer disposals mean less tax revenue, and HMRC’s own modelling assumes exactly this behaviour. Higher Capital Gains Tax therefore risks becoming a lose-lose policy, discouraging investment while failing to raise the revenues policymakers expect.
Making investment less attractive is the wrong way to fund tax reform
Making investment less attractive is the wrong way to fund tax reform. Instead, the government should focus on creating the conditions that encourage more people to invest for the long term. The UK already trails many comparable countries on retail investment. If ministers want to strengthen capital markets, boost productivity and help people build wealth, the tax system should support those aims rather than undermine them.
Lord O’Neill and his colleagues deserve credit for putting tax reform firmly on the agenda. Addressing the £100,000 tax trap would be a genuinely pro-growth change. But paying for it by reducing incentives to invest risks replacing one obstacle with another. Britain needs a tax system that backs long-term investment, rewards ambition and gives people the confidence to build their financial future.
Michael Healy is CEO of IG Consumer