Confiscation through inflation

Inflation has now reached its highest level for 20 years, today’s figures reveal. But we will suffer not just because of the increased cost of living, but also because the government will penalise us by taxing our illusory gains. The Adam Smith Institute has calculated that about half of the £3.3 billion that the government plans to raise through capital gains tax (CGT) next year (2011-12) will come from taxing purely inflationary gains.

“Fairness” is said to be an attribute of the coalition’s fiscal policy. But it is difficult to see how this can be seen as anything other than extremely unfair. The main CGT rate was raised from 18 per cent to 28 per cent in last June’s budget without taxpayers being allowed to deduct the inflationary element of gains.

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Calculating the amount of the tax take accounted for by inflationary gains is relatively simple. In the past, inflation was accounted for by an “indexation allowance”. The last year of the full indexation allowance for CGT was 1997/8. In that year, CGT receipts were £1.45 billion, and the Treasury estimated the ‘cost’ of the indexation allowance at £1.7 billion. So, without indexation allowance, CGT should have raised £3.15 billion. That implies that 54 percent of otherwise taxable gains were purely inflation.

The 2010 Budget estimate is that CGT receipts next year (2011-12) will be £3.3 billion. Applying the same 54 percent suggests that £1.8 billion of that is tax on purely inflationary gains. The different inflation profiles of the 1983-98 and 1996-2011 periods suggest that the inflation element of today’s gains would be slightly less than it was in 1998, but not by much: the 1998 figure of 54 per cent reduces to 49 per cent for 2011, which means that £1.6 billion of CGT receipts for 2011/12 will come from taxing purely inflationary gains.

So, the worse the performance in controlling inflation, the more revenue the Government raises from CGT. Inflation is already causing enough difficulties for citizens, especially the old who live on fixed incomes drawn from the sale of long-term investments — and who are by no means ‘rich’. To tax the results of this runaway inflation simply adds insult to injury.

The policy response should be clear. First, reintroduce an indexation allowance so that inflationary gains are not taxed. Second, reduce the CGT rate to a more reasonable level of 18 per cent or below. The government needs to stop penalising the elderly who are selling assets to help get by in these difficult times.