Capital gains tax raid could create one of the world’s most ‘anti-growth’ tax systems

Chancellor Rachel Reeves’s upcoming Budget threatens to push the UK towards having one of the least competitive tax systems in the developed world, according to a major new analysis by the US-based Tax Foundation and the UK Center for Policy Studies (CPS).

The report warns that if Labor introduces a widely expected increase in capital gains tax, the UK could fall further in the Organization for Economic Co-operation and Development (OECD) tax competitiveness ranking.

The UK has already fallen to 30th place out of 38 OECD countries in the Tax Foundation’s 2024 International Tax Competitiveness Index, as a result of actions taken by the previous government. However, the study suggests that further tax rises under Ms Reeves could see Britain fall another four to five places, putting it just ahead of France, Italy and Colombia in the overall rankings.

“There is a real risk that Britain will end up with one of the least competitive and most anti-growth tax systems in the OECD if the expected tax rises come to fruition in the budget,” warned CPS researcher Daniel Herring. If Labor really wants long-term economic growth, it needs to consider fundamental tax reform, rather than simply raising taxes.

Concerns about capital gains and dividend tax increases

The analysis focuses in particular on potential increases in capital gains tax and dividend tax. The PPS has modeled the impact of these measures, showing that an increase in capital gains tax could see the UK’s ranking fall to between 32nd and 34th place. Similarly, raising the top rate of profits tax to 45%, to bring it into line with income tax, would drop the UK two places to 32nd place. If both changes are combined with the proposed wealth tax, the UK could fall to 35th place, fourth from the bottom of the OECD rankings.

The changes are being considered as part of Ms Reeves’ wider tax reform agenda, which aims to raise £35bn in new revenue. While a wealth tax has been ruled out, tougher measures on capital gains tax and inheritance tax appear likely. The Chancellor is said to be reviewing the business and agricultural exemptions offered under inheritance tax, which currently gives a 50% exemption on the value of property and land.

The risk of brain drain and market destabilization

Wealth advisers warn that the proposed tax changes could lead to a “brain drain” as business owners consider moving abroad to avoid punitive taxes. Jason Hollands, managing director of Evelyn Partners, highlighted that many entrepreneurs are already exploring options to become non-resident if the UK tax environment becomes too hostile.

“There is a risk that we will end up exporting many of our entrepreneurs abroad, draining the job economy,” Hollands said. He noted that his company is already in many conversations with clients looking at the possibility of leaving the UK in response to potential tax increases.

In addition to the potential exodus of entrepreneurs, analysts have raised concerns that changes to inheritance tax breaks, particularly on publicly listed stocks, could destabilize investment markets. Hollands noted that the removal of Aim’s business subsidy could have a significant impact on the market, as a large portion of Aim’s investments are tied to tax mitigation strategies. He warned that removing business subsidies without transitional arrangements could lead to a wave of selling, further weakening the stock market.

“Aim is already facing a dearth of IPOs and a declining number of listed companies. Removing corporate subsidies would be a real death blow, especially if existing shareholders are given no incentives to stick around,” Hollands said.

Mixed messages on the pro-growth agenda

The potential tax increases come at a time when the government is promoting itself as pro-growth. A Treasury spokesman pointed to the record £63 billion of private investment secured at the recent International Investment Summit as evidence that the UK remains the top destination for business investment. They added that Ms Reeves’ Budget would continue to support businesses by capping corporation tax at 25% and publishing a business tax roadmap to provide long-term certainty for businesses.

However, medium-sized companies are still concerned about the budget impact. A recent study by accountancy firm BDO found that many of the 500 companies surveyed were concerned about rising costs and a lack of clarity about government policy. “These companies are demanding some certainty,” said Richard Austin, partner at BDO.

While the UK government walks a fine line between increasing revenues and maintaining competitiveness, the upcoming Budget will be crucial in determining whether Britain is able to balance its growth ambitions with a tax system that supports businesses and entrepreneurs.