Earned income taxed twice as heavily as capital gains for some in UK, study finds | Capital gains tax

A graduate earning £35,000 a year pays almost double the average tax of someone with the same income from rent on property, according to a study of inequality in the UK tax system.

The combined effect of income tax and national insurance payments forces people in employment to pay much higher rates of tax than those who benefit from lower capital gains tax (CGT) rates on property and shares income, according to the Intergenerational Foundation thinktank.

In a separate example that also emphasises the gap between the mainly older people who generate an income from property and shares and those who rely on employment, a person receiving £60,000 a year in the form of capital gains or dividends pays less tax than someone aged 16 to 64 in a job earning £35,000.

“Earned income, in such cases, is taxed two to four times more heavily than unearned income,” said the foundation, an independent charity that funds research into issues affecting young people.

Based on analysis of HMRC data, the foundation said increasing CGT rates to the same level as rates on earned income would raise at least £10bn extra a year, allowing the government to cut tax rates at each income tax threshold by at least 1.25 percentage points.

The momentum behind calls for the equalisation of capital and employment tax rates has grown in recent years. Recent polling has shown support across the political spectrum, with 61% overall saying they back reform.

Before it was scrapped, the Office of Tax Simplification said the tax system would be better designed if the rates for CGT and income tax were more closely aligned. It said putting CGT up to the level of income tax would raise £14bn.

The former Conservative chancellor Nigel Lawson set the rates of CGT at the same level as income tax in 1988, saying: “In principle, there is little economic difference between [earned] income and capital gains … And in so far as there is a difference, it is by no means clear why one should be taxed more heavily than the other.”

Since Lawson’s time in office, capitals gains have risen 16 times from below £5bn a year to an estimated £80bn in the financial year 2020-21, but the amount of tax raised from capital gains has only risen three times to about £15bn.

Higher rate taxpayers earning more than £50,000 a year pay 42% on every extra pound earned from employment, but pay only 20% on gains from shares and 28% from gains on property.

Standard rate taxpayers, which includes most taxpayers over the age of 65, only pay 18% on property gains, 10% on gains from shares and 20% on rental income.

The authors said the current system allowed for significant levels of avoidance by those with income from capital gains who were allowed to smooth the declaration of their income to make sure it fell under the tax threshold over a period of years.

“The wealthy obtain two main advantages from the current system not available to most of the population: first, a large lump of tax-exempt capital gains; secondly, a maximum tax of 20%, which is less than half the top rate of income tax,” the report said.

“Those who can manipulate the tax system in their favour tend to be those with high incomes or high levels of wealth, leaving a larger tax burden on younger people and those on lower incomes, further perpetuating inequalities between and within generations,” it added.

The tax privileges granted to those with unearned income in the UK are also over- generous by European standards, the report said. “For example, in Germany the annual exempt allowance is only €1,000 and all capital gains are taxed at 26.38%, while in France unearned income is taxed at 30-34%.”