I’m always pleased when campaigners about tax avoidance manage to find concrete examples of what they want changed. It takes a lot more knowledge and work, but is much more likely to have some impact in legislation.
So it’s great that 38 degrees have zoomed in hedge fund managers claiming their income as capital gains rather than wages. This not only gives them a lower tax rater, but makes it easier for them to claim numerous exemptions. The end result can be tax of just 12.7%.
Last week they released a report on the topic. It’s written by my friend Mike Lewis, and estimates the tax cost of this ‘loophole’ at £700 million per year.
38 degrees’ proposed solution is to explicitly treat payments to private equity employees as salary. That’s probably the right position for them to take — it’s a good change that might plausibly be implemented.
Personally, though, I’d prefer a much more radical change. It’s abhorrent to tax labour so much more highly than capital. This is something that brings out my inner socialist. The low rate of capital gains tax just shows that the system is rigged in favour of capitalists and against workers.
Thanks for such a kind post, Dan!
We did discuss more fundamental changes to the structure of taxes on capital when thinking and talking about this issue. As you say, that’s a question that involves a larger set of stakeholders than financial-sector millionaires, and a bigger set of policy questions: pricing-in inflation, incentives for investment, double taxation when the gain originates from value created in part by (taxed) corporate profits…
I have personal views on those questions that may accord with yours, but what we wanted to focus on was a tax provision whose use/abuse is explicitly protected by governments of all parties, and which is plainly economically unjustifiable whether you’re an economic conservative or not. I think these kind of examples show nakedly how the tax system is rigged in favour of the wealthy, *even* if you believe that capital gains should be taxed at lower rates than income.
One other aspect of the UK CGT regime that I think is also very difficult to justify is the CGT personal allowance, which has been increasing year-on-year since the 1990s, even (slightly) in real terms, and is plainly a tax break aimed specifically at the almost-exclusively middle- and upper-income earners who receive capital gains. And it’s now actually *more* (£10,900) than the income tax personal allowance (£10,000). HMRC estimates the revenue foregone from the CGT personal allowance at £3.5bn, making it one of the larger structural tax expenditures. As a comparison, £3.5bn is substantially bigger than the real-term savings (£2.5bn, according to the IFS) from welfare cuts over the last Parliament.
ps. I’m told that, in contrast to private equity and venture
capital, hedgies – at least in the UK and the U.S. – actually tend not to use the
carried interest loophole quite so much (though I’m also told the
distinction is not absolute). This is because hedge funds typically
don’t hold assets long enough to qualify for long-term capital gains tax
(in the U.S.) or for entrepreneur’s relief (in the UK). They may in
some cases qualify for simple CGT in the UK, though. On the other hand, lots of hedgies are non-doms anyway, and there are plenty of ingenious ways that their income from UK-based hedge funds is turned into non-UK income.