I hated school. So as a 12-year old I took the rumours of a ruthless new headmaster to heart:

• “He’s going to make us all wear bright blue blazers, bow ties, and caps.”
• “Girls will be separated from boys except at break and lunchtime.”
• “At his last school they had extra classes on Saturday mornings.”
• “He’s into caning, and we’re all going to get it.”

Of course none of this happened when the incoming man took up his thankless position. Though, looking back, the level of lawlessness at my big comprehensive did decline once the top slot was occupied.

As a nerdy if rebellious pupil, a stricter headmaster was good for me.

More physics, less fistfights.

But then we typically dread what might happen more than we suffer when it does.

Our imaginations – whatever our age – are uncapped by mundane reality.

Not my precious!

Alas, the new Labour government – and their nightmare-conjuring critics – are not dealing with fantasy.

Hemmed in by politically-motivated red lines on income tax, national insurance, and corporation tax, if chancellor Rachel Reeves wants to raise revenue then she has to go for somebody’s favourite tax relief, shelter, or break.

That might be inheritance tax. Or higher-rate pension tax reliefs, as debated in Monevator comments. Niche areas like ‘entrepreneur’s relief‘ or the way that private equity income is taxed as gains. The still fairly niche capital gains tax (CGT). Restrictions to ISA pot sizes or the annual ISA allowance.

Pick your poison: “Somebody is going to get it”.

The struggle is real

Let’s agree we don’t yet know what’s coming for sure.

These people aren’t idiots, unlike their predecessors from two or three administrations back. Their politics might not align with yours – nor mine exactly – but they’ve seen austerity has its limits and know growth is what the UK needs.

Yet they’ve inherited an impaired public sector where for a while people even wondered if an ambulance would show up in an emergency – versus expectations inflated by Brexit baloney about £350m a week for the NHS.

That didn’t happen. Just like immigration is higher, there’s no trade deal with the US, and any real economic benefit that might have eased giving up frictionless trade with Europe is notably absent.

The State collects around £40bn a year less in taxes than we’d have expected if we’d stayed in the EU.

I know some of you don’t like to hear it. But the impact doesn’t go away just because it’s boring.

Economists said Brexit would damage the UK economy, and here we are scrabbling for cash.

Of course there’s also been the massive hit from the pandemic, higher borrowing costs with higher interests rates, an increasingly job-shy population, and the energy market roiling war in Ukraine.

Oh, and the pensioner ranks continue to swell, leaving fewer workers to foot a growing welfare bill:

Source: ONS

Beyond the Punch and Judy show

Whatever your politics, it’s clear the UK is living beyond its means.

The Conservatives froze tax thresholds for years and dragged millions into the higher-rate tax bracket.

We all know they’d have cut taxes if they could.

Yet they left office with the NHS elective care backlog approaching a record 8m even while the tax burden was at the highest level for at least 70 years:

Source: ONS

There’s undeniably an issue here.

You want higher economic growth instead of tax increases? And something done about UK productivity?

You and me both. And Reeves and Jeremy Hunt for that matter.

But it’s far easier said than done.

Reversing Brexit would help, eventually, if we ignore the impact of all the division it would cause, and the further cost to business of undoing the border-related investments it had to make.

But frictionless trade with Europe is surely off the table for a generation.

The State could be shrunk, but goodness knows what’s actually achievable.

Perhaps we could throw in the towel on military spending? Accept we’re a middle-order player on the global stage, with influence that will only shrink as China, India, Indonesia – and eventually even the likes of Nigeria – advance?

Good luck getting that past Barry Blimp. Even I don’t think it’s wise while war rages in Europe.

As for trimming welfare spending, just look at the pushback against means-testing the winter fuel allowance for pensioners.

Logically a sensible measure, if we have to cut spending. Yet so unpopular it will possibly be reversed.

There’s a reason the state tends to grow inexorably over time.

The precautionary principle applied to taxes

Personally, if I was Reeves I wouldn’t change anything, except perhaps some loopholes such as carried interest on private equity.

(Even that’s of debatable benefit – it would surely lead to capital flight, and perhaps lower tax revenues in the long run. But it would throw a bone to the notion of taxing the richest, without doing too much wider damage.)

Instead I’d probably rely on extending the freeze on tax thresholds, and the resulting drag bringing yet more workers into the higher-rate tax bracket – even as inflation also pushes up the price of everything they need to pay for.

I’d borrow to make up the difference, at the cost of slightly higher yields and rates.

No, I don’t like it either. But it’s probably better than throwing cold water on the economy with taxes that target wealth creation.

Because we really really need to grow GDP.

Do we face a capital gains tax rise?

Maybe all this pre-Budget fear and loathing isn’t entirely bad news for the state coffers.

If people see less point in saving because of higher taxes or lowered reliefs to come, they’ll spend more money today.

That could boost growth now, at the cost of future gains. And at the cost of future tax receipts too, as a smaller pool of pension assets, say, will ultimately mean less pension income to tax in the distant future.

But Reeves might decide that’s a problem for next generation.

This logic – more money now, and hang the long-term consequences – is why there’s so much noise about capital gains tax (CGT) rates being lifted.

CGT is only paid in any given year by a small slice of the population – fewer than 3% in any given year.

So the vast majority of people who will never pay CGT can take an “I’m alright, Jacinda” attitude to the wealthy getting clobbered – and presume it’s a costless tax hike to them.

Rich versus poor. Elite versus everyone else.

It makes CGT the perfect battleground tax.

Rates up, receipts down

Of course, we know that there will be a cost for everyone to jacking up CGT rates, whatever the offsetting rewards that HMRC is able to collect.

For starters, take the notion that equalising CGT with a person’s income tax rates – so 40/45% at the highest band, from 20% today – will simply double CGT revenues towards £30bn.

Even in the short-term, some people simply won’t sell if rates rise. They’ll hope for better rates to come – or find another way to realise their assets, such as running their business for income.

Others will sell in advance of higher rates if they’re given advance warning. They’ll take a 20% tax hit upfront instead of a future 40% whack.

This might seem helpful to a cash-strapped government in a hole today. But it probably won’t do much for long-term revenues, unless we presume any realised gains will go back into investment, rather than being spent on foreign imports and holiday homes abroad.

A heroic presumption, given the climate will be seen as increasingly hostile to investment, at the margin.

You can see how higher CGT rates could eventually reduce the total capital gains tax take.

A rich take on a capital gains tax rise

Talking of overseas, while I’ve been told ‘the rich’ are set to leave the UK every year since I was a nipper – even as we gained more than our fair share of millionaires – it’s true capital is flightier than labour.

Monevator readers with perhaps a few tens of thousands invested outside of tax shelters will find the notion of re-domiciling overseas to avoid a 40% CGT hit an easy pass. It won’t be worth the hassle.

But if you’re a business owner, say, with seven/eight/nine figure assets that you expect to dispose of someday – or even to reduce steadily over time – then the equation is very different.

Moving to Monaco or the Bahamas to save millions could be the easiest money you ever make.

It’s complacent to assume the UK is such a great place to live that they won’t do it.

At the least it’s less attractive to the mobile wealthy than it was when a British passport enabled you to live anywhere in Europe – and potentially arbitrage over time into other European countries’ tax regimes, too.

Schools are often brought up as an obstacle. But there’s already an army of foreign kids in our public schools. Why wouldn’t our own wealthy would-be emigres do the same? Sending your kids abroad is very normal in wealthy circles elsewhere in the world.

True, ISAs are peerless tax shelters that lose their tax-shielding status under other jurisdictions.

But again, ISAs are far more meaningful to the averagely wealthy than the properly rich.

Will a hedge fund manager, pop star, or factory owner really be swayed by losing a £20,000 a year ISA allowance (and the wrapper around whatever is in their pot) if faced with a multi-million pound CGT hit?

From the LSE:

More than half (52.2%) of all taxable gains in 2020 went to just 5,000 people, who received an average of over £6.8m per person in gains.

That’s really not many people deciding to move abroad to make a difference in the numbers.

Squeeze them until the pips squeak!

Some people will say “sod them”. Paying taxes is your patriotic duty, they’ll argue.

A cynic would note they’ll argue this less when HMRC comes for them. (Pension relief, anyone?)

But for now, losing a few oligarchs and other pampered princelings (yes I know this isn’t accurate) may seem a small price to pay to ‘save the NHS’.

Well… fine.

Except that firstly, even doubling the CGT take to £30bn a year won’t fix the public sector. Were it even possible from jacking up rates. Which it’s not, for the reasons I gave.

And secondly, long-term we need economic growth and that means we need a dynamic risk-taking economy that encourages entrepreneurs and investment.

I’m not one who says all tax is theft or whatnot.

But when even a Tory government just left office with taxes at the highest since World War 2, we must ask whether enough is enough.

If not for moral or philosophical reasons, then simply out of self-interest.

The best – and I’d suggest only – way to generate CGT receipts of £30bn a year sustainably is to grow the economy such that many more of us are making big capital gains (and higher incomes for that matter), and paying taxes at reasonable rates where we don’t blanche and decide to take cover instead.

In the long-run, economic growth (with productivity growth) is everything.

And a capital gains tax rise will hardly encourage the investment Britain needs to further that agenda.

But that doesn’t mean politicians won’t do it. Plenty of countries have higher headline CGT rates than us:

Source: FT

Higher earners versus the wealthy versus the rest

The counterargument that justifies a CGT hike is that you must fish where the fish are.

Britain is a mediocre country for wealth, outside of the London and the richest cohort. And the latter have been getting ever richer.

Yet the better-off – as defined in income terms – are already paying a vast share of income tax:

Source: TomHCalver / Sunday Times

What is arguably undertaxed in Britain – whether by design or the machinations of those affected – is wealth.

And while hiking CGT has its issues, it does at least target (some of) those with the most assets.

Reeves has previously made comments that she understands a capital gains tax rise isn’t optimal, stating on the BBC’s Today programme in March 2023:

“I don’t have any plans to increase capital gains tax. There are people who have built up their own businesses who maybe at retirement want to sell that business. They may not have had huge income through their life if they’ve reinvested in their business, but this is their retirement pot of money.“

But maybe she’ll decide she has no choice.

Action stations ahead of a capital gains tax rise

We’ve written a lot about capital gains tax over the years.

Have a read of:

• Capital gains tax in the UK
• Capital gains tax on shares
• Defusing capital gains: a worked example
• Tax-efficient investing in the UK
• How high taxes reduce your returns

If you’re thinking about selling buy-to-let property ahead of a CGT rise, look for articles from specialists. Property is lumpy and illiquid and you can’t stick it in an ISA. But other measures may apply.

Clearly all our CGT information could be out-of-date once we see Reeves’ autumn statement.

Set a calendar reminder for Budget day on Wednesday 30 October!

Action stations

Should anyone take action ahead of knowing whether we’ll actually see a capital gains tax rise?

My crystal ball is as foggy as yours.

We do get these fears about inheritance tax, pension reliefs, and the rest every year. Scaremongering is an asset-gathering strategy of the financial services industry, even when its claims are well-founded.

I’m sure everything being fretted about won’t come to pass. But too much has been floated without official pushback for something not to happen.

If you do believe you’ll be in the CGT firing line and you want to take action, act sooner rather than later.

Reeves might impose any changes from midnight on Budget day. There’s a precedent – George Osborne did it with his CGT hike in June 2010.

Clearly the aim would be to stop tax mitigation if the changes were scheduled for the new tax year, starting 6 April 2025.

But again, nobody – probably still not even Reeves and Starmer – knows exactly what is coming.

Big picture, it seems counterproductive to me to forestall investment or have people dump unsheltered AIM shares, say, if you’re also trying to promote a vibrant UK economy.

But politicians follow a different calculus.

Perhaps they hope the fear of a vicious budget will offset teeth-gnashing over a mildly unpalatable one.

What are you doing ahead of a capital gains tax rise?

I’m curious what the Monevator massive is thinking.

We do have a few multi-millionaires in our ranks – and a majority of our readers declared themselves to be higher or additional-rate taxpayers.

We’re clearly wealthier than average, and we’re into investing. Squarely in the firing line, if wealth tax worries prove accurate.

Let’s have a poll:

As always, I know this is a crude approximation of a complex array of choices. Just pick the nearest and most honest answer. Ideally give your reasons in the comments. And please don’t bluster about moving to Singapore to avoid a feckless socialist takeover if you know you’ll never go anywhere in practice.

Looking forward to a constructive discussion!

What caught my eye this week.

Back when passive investing first began to make serious inroads into the active investing orthodoxy – say 20 years ago – its adherents could be testy.

With none of the amiable grace of Vanguard founder Jack Bogle – whose own son runs an active fund – some passivistas would shout down, sneer at, or stonewall any signs of opposition to their creed.

I suppose it was defensiveness.

Now that even a Sunday newspaper will tell you to buy an S&P 500 tracker, it’s hard to recall when investing in index funds was a fringe pursuit. Something best left to people of low ambition and little intelligence, who’d rather a witless robot picked stocks and who’d prefer to run into the buzzsaw of the Dotcom crash than make a few ‘easy’ decisions to get superior returns.

Actually, when I put it that way then, yeah – the active investing diehards could be just as annoying, too!

I remember the balancing act required in moderating comments on this blog. As a person who loves investing in all its stripes – and who picks stocks as much for sport as the hope of a serious return – I never vibed with this ‘with us or against us’ attitude that some readers lent into.

Here’s the evidence, make your own mind up – that’s been my approach.

Passive is almost certainly the best and easiest way for you to achieve your returns. But you do you.

All in it together

Things have calmed down in the last few years. Surely because index investing is no longer an underdog.

Indeed at the end of 2023, passive funds in the US actually overtook active funds in terms of assets under management for the first time.

The rest of the world is close behind, and the direction of travel is clear.

A good few of us still enjoy investing in companies directly or tilting our mostly-indexed portfolios with side bets (and come join us on Moguls if that’s you).

But I honestly can’t remember the last time an arrogant commenter turned up on Monevator calling all index investors complacent idiots. It was years ago.

You do still sometimes see that attitude elsewhere – on hives of S&V like the ADVFN bulletin boards, say.

However I’d suggest the majority of smart retail investors now understand the strong argument for passive investing in index funds – however they run their own money.

The price is right

Even Eugene Fama seems to have taken a chill pill.

The Chicago economist – whose 1965 paper Random Walks in Stock Market Prices underpinned the intellectual case for the first index funds that arrived a few years later – told the Financial Times this week: “Efficient markets is a hypothesis. It’s not reality.”

The FT says:

Fama is surprisingly phlegmatic when it comes to defending his life’s work, echoing the famous British statistician George Box’s observation that all models are wrong, but some are useful. The efficient market hypothesis is just “a model”, Fama stresses. “It’s got to be wrong to some extent.”

“The question is whether it is efficient for your purpose. And for almost every investor I know, the answer to that is yes. They’re not going to be able to beat the market so they might as well behave as if the prices are right,” he argues.

Fama also makes a good point when he admits to some regrets about choosing the word ‘efficient’ to describe markets.

‘Efficient’ sticks in the craw of those who’ve through bubbles and crashes and who struggles afterwards to see an intelligently discounting market at work.

Easy now! You don’t need to revive the old fighting spirit to shout at me. I understand boom and bust is not incompatible with efficient markets. I’m just saying many people do struggle with the concept.

Anyway Fama has the best rejoinder…

“If prices are obviously wrong then you should be rich,” he says.

Have a great weekend.

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