Capital gains tax (CGT) in the United Kingdom has become a focal point of debate as policymakers consider reforms aimed at addressing long-standing issues of fairness, complexity, and revenue generation. Despite raising approximately £20 billion annually—far less than the £360 billion collected through income tax—CGT reform has garnered attention from figures including Wes Streeting, Louise Haigh, and supporters of Andy Burnham, who advocate for aligning CGT rates more closely with income tax rates.

Currently, rates of CGT vary by asset type, generally standing at 20% for higher-rate taxpayers, with higher rates applied to residential properties (24%) and carried interest (28%). Gains of up to £1 million on business disposals are subject to a reduced rate of 10%. These rates are significantly lower than income tax rates, creating incentives to categorize income as capital gains. Consequently, tax authorities have implemented complex rules to limit avoidance, though these often result in ambiguity and a cumbersome tax code.

Critics argue that taxing capital gains at lower rates than income is inequitable, especially since such gains can result from both labor and luck. On the other hand, simply increasing CGT rates to match income tax rates may discourage investment and entrepreneurial activity, potentially decreasing overall tax revenue. This dilemma has led to decades of incremental and sometimes inconsistent adjustments to the tax system.

One proposed solution involves equalizing the rates while taxing only the real gains—that is, gains exceeding inflation and a risk-free return—rather than nominal gains as is currently done. Historically, the UK applied such an approach in the late 1980s and 1990s. Proponents contend that this method could balance efficiency, equity, and revenue objectives by targeting “super normal” returns without penalizing ordinary investment growth.

Economic researchers Arun Advani and Andy Summers estimate that reforms of this type could raise over £10 billion in additional revenue, primarily from taxpayers at the top of the income distribution who realize the largest capital gains. However, successful implementation would require complementary measures to close existing avoidance channels.

Presently, taxpayers can avoid CGT through two main strategies: deferring sales until death, as CGT liabilities are waived on inheritance, or by establishing non-residency outside the UK before asset disposal, thereby evading UK tax. Raising CGT rates without addressing these escape routes could exacerbate tax avoidance, reduce revenue, and distort economic behavior.

Countries with comprehensive CGT frameworks employ mechanisms such as exit taxes and deny step-up in basis at death to mitigate these risks. Nonetheless, adapting such reforms poses significant complexity and political challenges. Additional improvements, including better loss offsetting provisions, are also necessary for a more coherent system.

Experts caution that while CGT reform is needed, the process involves difficult trade-offs requiring detailed policy design and careful implementation to avoid unintended consequences. The challenge is to develop a system that is fair, fosters investment, minimizes avoidance, and generates sustainable revenue, all within a complex and often contradictory landscape.