Capital gains tax (CGT) is in need of serious reform as the whole design of the tax is “flawed”, according to the Institute for Fiscal Studies (IFS).

In its Green Budget 2024 paper, the think tank argued that simply raising the rate of CGT was not the right route to take, and there were steps that the government should take to make the tax fairer and less harmful to economic growth and wellbeing.

It called for several reforms to the tax, including ending the uplift of CGT at death, aligning tax rates across all forms of gains and income, removing business asset disposal (BAD) relief while giving more generous deductions for investment costs, and introducing a tax on people emigrating from the UK on their accrued but unrealised gains.

The analysis, co-authored by researchers at the IFS and CenTax, found that CGT raises a growing amount of revenue, around £15bn last year, which partly reflected the increasing role of wealth accumulation in the UK but still accounted for less than 2 per cent of total tax revenue.

While around 350,000 people pay CGT each year, two-thirds of CGT revenue comes from just 12,000 people.

It noted that CGT rates vary across assets and are almost always lower than tax rates on income, and argued that these rate differences were unfair and created “undesirable distortions”.

Furthermore, the think tank said the design of the tax base reduced UK productivity and growth by discouraging saving, investment and risk-taking, and leading to a misallocation of capital away from its most productive use.

There are some investments that are commercially viable before tax but are deterred by CGT, the IFS said, and if these problems remain unaddressed, they would be significantly worse at higher tax rates.

However, keeping CGT rates low cannot solve these problems, the paper argued.

“In contrast, a well-designed tax base would greatly reduce – and in many cases largely remove – these problems,” it stated.

“This would involve giving full deductions for any amounts of money saved or invested and more flexible treatment of losses.”

The think tank called for the uplift of CGT at death to be ended, as it felt it was unfair and created an incentive for people to hold on to assets past the point it is efficient for them to do so, and for the tax base to be reformed with tax rates to be aligned across all forms of gains and income.

It also said that removing BAD relief and giving more generous deductions for investment costs could boost investment while raising revenue from the top of the income distribution.

Finally, it called for the introduction of a tax for people leaving the UK on their accrued but unrealised gains, while exempting new arrivals from UK CGT on gains they made whilst living abroad.

It noted that while this would raise “practical challenges” and the design issues would have to be carefully considered, the approach was already operated by some other countries.

“CGT is a small but important tax. Its design is flawed and this matters for both the efficiency and fairness of the tax system,” commented IFS deputy director and report co-author, Helen Miller.

“The new Chancellor should use her first Budget to create a CGT that is fairer and more growth-friendly. The only way to do this is to reform the tax base alongside increasing tax rates.

“Getting the design of any reform right is crucial. But a sensibly reformed CGT would be a significant prize and should be a priority regardless of how much revenue she would like to raise overall. Good reform would also make it easier to raise significant additional revenue.

“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. That would not be the decision of a Chancellor who was serious about growth.”

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