Expect housing sector chaos if capital gains tax goes up

Labour donor Dale Vince’s proposal would fall victim to the law of unintended consequences, warns David J Alexander.

The news that Labour donor Dale Vince is recommending substantial increases in the rate of Capital Gains Tax (CGT) will have sent a shiver down the backs of property investors, landlords, and second homeowners. At a time when substantially more investment is required in the private rented sector (PRS) this would be a callous and self-defeating blow which will only do harm to the market.

The proposal is to raise CGT to as high as 45 per cent in order to raise £14 billion to fund an increase in the personal tax allowance. But the impact on investment, on housing, and on assets would be enormous and the likely tax take considerably lower than Vince’s paper predicts.

The impact of an increase in the capital gains tax would have both an immediate and long-term impact on the housing market. If an increase in the rate of CGT is announced by Chancellor Healey then property transactions would immediately slow down as investors hold on to their assets for longer to mitigate against the higher charges.

This would result in fewer sales, reduced supply, and limited mobility across the whole market. Among landlords and investors there would be some who choose to sell up before the tax change begins, assuming an advanced date is announced. This would result in reduced supply for tenants, higher rents, and shortages in the PRS.

Over time there would be lower demand, potential price stagnation and property as an asset and investment would lose its appeal, producing long-term issues for the sector. There would be an immediate increase in waiting lists for social housing and potentially a rise in homelessness in Scotland which is already at a record level. Where would all the tenants currently living in the private rented sector go if its size is reduced by this tax take?

Housebuilding across all tenures in Scotland is currently at a 13-year low and would need to expand rapidly and substantially if CGT rose and shortages increased.

The problem is that all of these proposed tax increases don’t factor in changed habits. Unless investors have to sell they may sit on their properties for longer, waiting for the inevitable tax reduction if a change of government occurs. These plans are always predicated on the idea that investors will continue to behave the same way as when the tax was lower. But investors are flexible, they are mobile, and they have options. The tax take is unlikely to be as predicted due to many differing factors.

Instead of increasing taxes, it would be better to encourage investment, develop a more benign tax regime which produces growth, and expand the private rented sector through support and incentives. Contraction occurs when taxes are increased and growth happens when they are cut.

While an increase in CGT sounds like a simple fix it is simply tinkering at the edges. Every tax rise produces unintended consequences, and CGT is particularly unfair as it is generally a tax on inflation rather than actual accumulated wealth. Over the last decade UK average house prices rose by 38.8 per cent while inflation for the same period was higher at 41.8 per cent. So, this isn’t an enormous financial gain it is simply an inflationary increase. Any changes to the CGT tax take would be unfair, self-defeating, and cause chaos in the housing sector.