Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is chief executive of Hargreaves Lansdown
Britain suffers from a material investment gap. Millions of individuals are stuck in cash, watching their hard-earned savings erode from inflation while missing out on the long-term financial security that disciplined investing can create. By some estimates, more than £600bn is trapped in “excess cash” that could be invested. This hurts both wealth creation for individuals and growth prospects for the country, as deep, broad and liquid capital markets are the lifeblood of a strong economy.
No single solution can solve this problem. Investors need access to more helpful, straightforward and intuitive offerings; financial education and guidance need to reach more people across the country; and firms need to make it easy to move from cash to investment.
Government can also play a role. It has already made building a stronger retail investment culture a stated priority. It can go further through policy certainty, regulation that supports economic growth and a tax structure that encourages investment.
Recent suggestions that capital gains tax rates should be increased work against this goal. A well-established economic principle is that you get less of what you tax. If increasing investment is the goal, increasing the tax on investment returns will only hurt that goal.
In addition to hindering investment, raising capital gains tax rates to equal income tax rates misses a crucial distinction: investment returns are not economically identical to a salary. A salary is paid regularly in return for work. Investment returns are uncertain. Investors commit money that has often already been taxed, accept the risk of losing some or all of it and may wait many years before receiving a reward. Taxing the two identically would ignore that one is earned income while the other is the uncertain reward for putting capital at risk over time.
What may appear to be a modest tax increase is more material than most realise. Consider someone investing £100,000 outside a tax-advantaged account and earning a 10 per cent return over one year. Assuming their £3,000 annual capital gains allowance has already been used, a £10,000 gain taxed at 24 per cent (the current capital gains tax rate) leaves them with £7,600. Taxed at 45 per cent, it leaves them with £5,500. The tax rate has risen by 21 percentage points, yet the investor’s after-tax return has fallen by almost 28 per cent.
People respond to incentives, and a significantly increased tax on investment returns changes the risk-reward calculation. Surveys have shown that UK consumers already overestimate by as much as seven times the probability of losing money from investing over a 10-year period. For households already hesitant to invest, a much smaller share of any return could be enough to keep their money in cash. Others might defer selling investments, concentrate more heavily on tax shelters or look to other markets with more favourable tax treatment.
These factors extend to private markets. Entrepreneurs and business owners often rely on private investment to give them the capital they need to grow. Thriving businesses create jobs, products and services that benefit consumers, and the dynamism that marks the world’s strongest economies. A higher capital gains tax will reduce projected returns for investors, diminishing both their willingness and capacity to deploy capital in the UK.
Britain needs a capital gains tax regime designed for today’s circumstances. The government cannot ask people to invest more, entrepreneurs to take more risk and capital to back growing businesses while planning to take a much larger share of any reward. Any reform must therefore examine holding periods, the effect of inflation, tax allowances and how capital gains tax fits alongside Isas, pensions and general investment accounts.
There is a wider point about confidence. Investors are more willing to commit capital and take risk when the rules feel stable and understandable. Repeated speculation about major changes to capital gains tax, pensions or Isas encourages caution. It gives people another reason to wait when what we need them to do is plan, invest and build wealth over time.
The government has rightly emphasised its goal to spur economic growth and retail investment participation. It needs to follow through by judging any reform against a straightforward test: will it help more people invest with confidence and allow more capital to reach productive businesses? The answer to that question will do much to determine whether the UK’s investment culture strengthens or stagnates.
