IFS calls on Labour for ‘serious reforms’ of capital gains tax

As Labour prepares for its first Budget under Chancellor Rachel Reeves, the Institute for Fiscal Studies (IFS) is urging the party to pursue sweeping reforms to the capital gains tax (CGT) system. The influential think tank has argued that without a more comprehensive overhaul, merely raising rates would be ineffective, potentially stifling growth and productivity.

According to the IFS report released on Sunday, the current CGT system is flawed, leading to inefficiencies that inhibit investment and distort capital allocation. While CGT raised £15 billion last year, accounting for less than 2% of total tax revenue, the IFS contends that its current design reduces UK productivity by discouraging saving, investment, and risk-taking. The report emphasises the need to eliminate preferential treatments and inconsistencies that skew investment decisions.

One of the report’s central recommendations is to align CGT rates with income tax rates, which would significantly increase CGT charges on many assets. “Capital gains tax needs serious reform, not just more tweaks,” noted Helen Miller, Deputy Director at the IFS. “Its design is flawed, and this matters for both the efficiency and fairness of the tax system.”

Current Design Discourages Optimal Investment

Under the present regime, CGT rates are typically lower than those applied to income, leading to “undesirable distortions” in how individuals choose to work, save, and invest. For example, the highest rate of CGT on assets such as shares is 20%, while the top rate of income tax is 45%. This disparity encourages taxpayers to channel their earnings through investments rather than income-generating activities.

The IFS argues that such disparities create powerful incentives for tax planning, distorting the flow of capital and leading to misallocation. “Ultimately, we advocate aligning marginal tax rates across all forms of gains and income, while reforming the tax base,” the report states.

This reform, the IFS suggests, would involve removing business asset disposal relief—a preferential CGT rate for business owners—which the report claims is not well-targeted at fostering entrepreneurship. Instead, the think tank advocates more generous deductions for investment costs, which would boost growth without the distortions created by current relief schemes.

Ending CGT ‘Forgiveness’ at Death

One particularly contentious proposal put forward by the IFS is to end the current practice of ‘uplift’ or ‘forgiveness’ of CGT at death. Currently, when an individual dies, their beneficiaries inherit the assets at their market value at the time of death, effectively resetting the CGT base and erasing any accrued gain. The IFS argues that this policy incentivises individuals to hold on to assets for longer than is economically efficient.

“This creates a very big incentive for people to hold on to assets well past the point at which it is efficient for them to do so,” Miller explained. Eliminating the uplift at death would not only generate additional tax revenue but could also encourage more active management and redistribution of capital.

However, the report acknowledges that raising CGT rates without altering the underlying tax base would be counterproductive. According to HMRC estimates, a 10-percentage point increase in CGT could result in a revenue loss of £2 billion by 2027-28, as individuals delay the sale of assets or move abroad to avoid paying the tax.

Tackling the ‘Exit Tax’ Dilemma

The IFS report also warns that higher CGT rates could push wealthy individuals to emigrate before realising gains, thus escaping UK taxation. One solution proposed is an ‘exit tax,’ which would levy CGT on accrued but unrealised gains for individuals leaving the UK. “This would raise practical challenges and the design issues would have to be carefully considered,” the report states, noting that such policies are already in place in countries like Canada and Australia.

Introducing an exit tax could, however, make the UK a less attractive place for international investment. To mitigate this, the IFS suggests exempting new arrivals from UK CGT on gains made while living abroad, creating a more balanced approach that could both curb emigration and attract new investment.

Political and Economic Implications

With Labour’s election manifesto pledging to “boost economic growth amid high taxes and the highest public debt since the 1960s,” Rachel Reeves faces the challenge of balancing revenue generation with economic incentives. The IFS argues that a mere increase in rates would achieve neither.

“If the Chancellor chooses to raise CGT rates while leaving the flawed tax base unchanged, she would be choosing to raise some, limited, revenue at the expense of weakening saving and investment incentives and further distorting which assets people buy and how long they hold them for,” warned Miller.

Broad Support from Other Think Tanks

The IFS is not alone in its calls for a fundamental rethink of CGT. The Resolution Foundation and the Institute for Public Policy Research (IPPR) have also suggested that comprehensive reforms are needed to ensure the tax is fairer and more conducive to long-term economic growth.

Ultimately, the IFS is pushing for a system that both raises revenue more effectively and supports investment—a “win-win” that could help the Labour government address fiscal challenges without undermining the country’s growth prospects.