Nasty double whammy for investors

Allister Heath
WITH all the focus on growth and the deficit, too little attention has been paid to inflation. Yesterday’s disastrous figures show how unwise this has been. The rise in the official consumer price index inflation to 3.7 per cent is bad enough – but I suppose it can be tolerated, given the ending of quantitative easing. But what is scandalous is the increase in the retail price index, the broadest measure of inflation, which includes mortgages and some property costs, to 5.3 per cent (and 5.4 excluding mortgages). Yes, you heard that right – it is the fastest rate since 1991. This is way too high and unacceptable in a modern democracy. Someone with £10,000 in savings will be losing over £500 a year in purchasing power, a hidden tax that will wreak havoc. What makes it even more damaging is that it comes at a time of low interest rates and high taxation. No wonder so many people are feeling under siege.

Three cheers to John Redwood, Lord (Michael) Forsyth of Drumlean and other top Tories for their campaign for a less punitive capital gains tax. They are trying to influence chancellor George Osborne’s policy review. While he is (regrettably) committed to hiking the tax (currently at 18 per cent) to align it more closely to income tax (40-50 per cent for most investors), the details have not been decided, so there is still quite a lot to play for.

My own view is even more radical: capital gains tax is an arbitrary form of double taxation that should be either repealed or at least reduced. The tax didn’t even exist until it was introduced by Harold Wilson in 1965; it has already been abolished in countries such as New Zealand, Holland, Hong Kong and Switzerland.

Asset prices are defined in finance theory as the net present value of their expected future cash flows: dividends in the case of shares, rents in the case of buy to let properties, appropriately discounted by the right risk-adjusted interest rate. There are, of course, other factors that affect asset values, especially during bubbles; but that general definition holds.

The taxman already takes a bite out of corporate profits – and whatever is paid out in dividends is taxed again. Rents are also taxable income. So capital gains tax – taking another chunk of the expected increase in future post-tax rents or profits – is a case of triple taxation in the case of corporate earnings and double taxation in the case of homes. It is pernicious.

Hiking capital gains tax will encourage debt by making equity far less attractive by drastically reducing post-tax returns. The system is already biased against equity: interest payments by companies are tax deductible, unlike dividend payments – and pension funds don’t pay tax on the interest they receive, while since 1997 they pay tax on dividends they collect. Higher gains tax will throttle the private rental market, making it far less worthwhile for investors to let out property, as the Institute of Economic Affairs points out. It will cut the supply of homes for sale as investors will be loath to realise gains and hence pay tax. It will trash the investments of individuals and force many to postpone their retirements.

Some people are able to disguise income as capital gains, though not small shareholders or property investors – but powers already exist to stop this, or if they don’t they should be given to HMRC. Let’s hope Osborne listens to Redwood and Forsyth.