Capital Gains Tax

“As we tackle regulation to create the best environment for business to thrive, we also have to design our tax system to encourage and reward work, savings, investment and enterprise. ...

“And we will continue to look ... at the business tax regime so that we provide incentives for investment in wealth creation and rewards for success.

“Indeed, we have an opportunity before us now to create a consensus on tax as well as on stability to make Britain the best place to do business.”

Gordon Brown 2005
http://www.hm-treasury.gov.uk/newsroom_and_speeches/press/2005/press_15_05.cfm

Of course, any savvy businessman would have seen through this piffle right away. But, after the debacle with the recent capital gains tax reforms, even the most gullible company owner must now see Gordo and Darling as a busted business flush.

Following Labour’s rise to power in 1997, entrepreneurs and investors were serenaded by the cut in CGT from 40% to 10% (something the Tories should have done years before). The sceptical asked if this was a short term ruse or could Labour be trusted to keep the rate at that level until their investments matured.

Then that trust was torn up with last autumn’s proposal to hike rates back up. Not only did it show flabbergasting ineptitude – the idea was to stiff the private equity barons – but also short term speculators were given a 55% tax cut while the downtrodden entrepreneur and long term investor were faced with an 80% tax rise.

Now, the latest idea is to muddle through a fudge with some sort of special ‘entrepreneurs relief’ for the first £1 million in capital gains. This might seem a lot but it just won’t do.

It’s a lifetime million, which isn’t all that much really – not enough to buy a decent house in many parts of the country.

It’s as if they’re saying it’s OK to be a small business but don’t dare be successful and grow into a big business. The tremendous results that incentives create in driving desired behaviour are widely known – even to someone as out of touch as our Chancellor Alastair Darling. But lefty politicians the world over just can’t bring themselves to do what they know intellectually to be right. They are still hidebound by a discredited ideology – Old Labour’s hatred of enterprise, initiative and incentive always outs in the end.

Some, maybe most, entrepreneurs when they’re just starting up perhaps don’t think too much about the tax they’ll pay on exiting their businesses (they soon will when it comes time to sell). But, their financial backers, the people who invest in entrepreneurial ventures, certainly do.

They’re not in it for the love of the game, they’re in it to make a profit. Good on them – we all benefit as a result. They take a huge risk and if there’s not a commensurate prospect of reward they simply won’t invest.

But, with an 80% tax hike the government has stuck two fingers up to them. They’ll get the message quick enough and either stop investing or go somewhere that does appreciate them.

In fact, the very concept of taxing investment (as opposed to speculative) gains is perverse. All wealth has its origins somewhere in entrepreneurial activity. Without entrepreneurs we’d be stuck living in caves – they still do in some parts of China where capitalism has yet to reach, and North Korea seems to be heading that way too!

As much as they may hate the idea, governments need entrepreneurs. They need them desperately. Entrepreneurs create businesses that pay taxes other than CGT. There’s VAT on everything they sell, and a tax on any profits they make. They create employment, which reduces the government’s welfare bill. Those employees are wealthier than would otherwise be the case (we assume the government thinks an increase in national wealth is a good idea) and they pay tax on their salaries.

The government gets a triple whammy for every business that flourishes. So why do they try so hard to obstruct it? (Answer: politics of envy.)

The government should be doing everything it possibly can to encourage entrepreneurs and their financial backers. This means genuine, meaningful reductions in bureaucracy (not token, empty gestures) and a tax regime that really does incentivise desired activity to the maximum.

Instead, the government lets someone else take all the risk and then snatches a great chunk of the reward. Some taxes such as employers’ national insurance even have to be paid by the business before there’s any profit!

A reduction from 40% to 10% might seem great, but it is still 10% too much. Not only should capital gains on all genuine entrepreneurial activity be abolished, there should be a special, lower rate of income tax for entrepreneurs. The capital gain reward is only realised once the business is sold, there is no incentive to keep being entrepreneurial within an existing enterprise.

If Gordon Brown really meant what he said back in 2005, there would now be no CGT on entrepreneurship, and a flat income tax rate for entrepreneurs of about 5%-10%. Red tape, administrative burdens and oppressive anti-employment legislation would be a thing of the past. That would mean, of course, some tough battles with the EU. But, if we really are going to be the best place in the world to do business these dragons will have to be slain.

February 2008