Why raising capital gains tax could reduce revenue for the government

It is widely expected that capital gains tax will make an appearance in next month’s Budget - but according to HMRC figures, hiking the tax could actually decrease revenues for the government.

Chancellor Rachel Reeves will deliver the Labour government’s inaugural Budget on 30 October. Prime minister Keir Starmer has warned that it will be “painful” and contain “tough decisions”.

Following the controversial announcement in July to scrap the Winter Fuel Payment for millions of pensioners, savers and investors are bracing themselves for tax hikes in the Budget.

Labour has ruled out increases to income tax, National Insurance, VAT and corporation tax - meaning speculation is growing that capital gains tax (CGT) could be increased or reformed to generate more tax revenue.

The government has repeatedly stressed that it needs to raise money to plug a £22 billion black hole inherited from the Conservatives.

But according to HMRC’s own projections, hiking CGT could result in a decrease in revenues. We delve into the figures, and look at the rationale for these projections.

How much could revenues fall if CGT was increased?

It might seem straightforward to assume that higher tax rates would boost HMRC’s revenue. But hiking taxes does not necessarily lead to more money for the government.

Let’s look at how much money CGT currently raises. In the 2023/24 tax year, CGT is estimated to have generated about £14.5 billion for the Treasury out of a total of £829 billion collected by HMRC, equating to less than 1.75% of tax revenue.

If Reeves raises the higher CGT rate by 10 percentage points, HMRC’s projections estimate that this would lead to a £2.025 billion reduction in revenue by 2027-28, equating to roughly a 7.5% decrease in CGT revenue over a three-year period.

Laura Suter, personal finance director at AJ Bell, says CGT “may not be the cash cow that many think it is”. She adds: “The government’s own figures show that a big increase in CGT rates could backfire and actually lead to lost revenue for the government.”

Why could raising CGT reduce government revenue?

The accountancy firm RSM UK submitted a freedom of information request to HMRC to understand the rationale for its projections.

According to RSM, HMRC’s response shows that it considered the impact of CGT rising from 20% to 30%. This would assume a 50% increase in tax yield, but doesn’t account for anticipated behavioural changes.

“HMRC’s calculations then assume that a rate increase would lead individuals to reduce the number of gains they realise during the period. This assumption is based on analysis of historical changes to UK CGT rates and the resulting behaviours,” notes Kate Clews at RSM.

“HMRC’s calculations also consider the knock-on impacts on other taxes. It is expected that income tax receipts will increase as taxpayers substitute income for gains. Conversely, the opposite effect is anticipated for stamp duty land tax (SDLT). The revenue generated from SDLT declines primarily due to the anticipated decrease in individuals making CGT-liable property disposals due to the higher rate.”

The projections assume that a CGT hike will be introduced in April 2025.

Clews adds that it is not clear what the Treasury’s own modelling looks like for increasing CGT. “Perhaps unsurprisingly, when a request was made to the Treasury to share details of any modelling undertaken on the impact of higher CGT rates for the most recent tax years, access to this information was denied.

“It was acknowledged that the Treasury holds such data, implicitly indicating that this has been an option that has been looked at in recent years under the Conservative government. Nevertheless, the data was withheld on the basis that it helps ensure the government has a ‘safe space’ to ‘consider policy options in private’.”

The previous government cut the capital gains tax allowance twice in a bid to balance the books, slashing it from £12,300 to £6,000 in April 2023, and halving it again to £3,000 from April 2024.

Suter agrees that a big increase to CGT rates could lead to a lower tax take as “investors would be expected to change their behaviour to mitigate paying the tax”.

Tax firm Blick Rothenberg also warns that while the government has inherited a healthy tax income, any tax rises in the October Budget could make it disappear.

Joe Neal, a manager at the firm, explains: “HMRC collected a healthy £82.5 billion in July 2024 which is the highest tax takings ever for a month of July and up from £81.3 billion 12 months earlier.

“However, taxpayers already are feeling that the tax burden is high and any further tax rises could be the tipping point that drives wealthy individuals and large companies to leave the UK - making Labour’s healthy tax income quickly disappear.”

What about a smaller rise to CGT?

Reeves may be tempted to increase CGT by a smaller amount to secure a small boost to tax revenue - rather than risk losing revenue by announcing a big increase.

HMRC’s projection shows that raising the higher CGT rate by 1 percentage point could bring in an extra £170 million in 2026-27 and £110 million in 2027-28.

But these amounts may seem too small given the government says it needs to find billions of pounds to fund spending commitments.

The biggest boost to tax revenue by tinkering with CGT, according to HMRC, would be via an increase to the business asset disposal relief rate. Hiking it by 10 percentage points could net the government £1.56 billion over the next three years.

We explore this further in Will Labour hike capital gains tax on business sales?