November 16, 2023

Tax Is Killing UK Capital Markets

Tax Is Killing UK Capital Markets

UK stock markets are in a tragic condition and politicians are to blame.

They trade at a discount to global equity markets of some 23%, making it exceedingly challenging for companies in Britain to raise new investment capital. No wonder investment into the British private sector has been the lowest in the G7 for years.

Our capital markets have developed “an unwelcome reputation as a backwater in 21st century equity markets” in the words of top fund manager Nick Train. The value of the UK market has declined from $4.2 trillion in October 2007 to $2.8 trillion today.

The AIM market, the junior section of the London Stock Exchange, is in crisis. It has declined in value by 27% since 1996. This year there have been just 11 new issues (IPOs) on AIM, the lowest number for 24 years. By contrast, in the 2005-7 period over 400 companies were brought to market on AIM every year.

This market is where our new companies are meant to grow.  It’s meant to be the incubator of the successful new companies of the future. But it’s dying.

Tax policy is primarily to blame.

An agenda for pro-investment tax reform

Capital Gains Tax (CGT) is a killer, particularly for start-ups and other high-risk assets. Inflation accounts for a large part of any taxable gain. If you invested £10k in 2020 and sold for £13k today your "gain" would be wholly due to inflation.

Critically CGT raises the rate of return required for investment into start-ups, making low risk assets more attractive.

The objective should be to eliminate CGT altogether, but interim steps should include lower rates for start-ups and for companies on the AIM market. Gains should be indexed against inflation. In the longer term, all shares held for more than 4 years should be exempt from CGT.

We should also restore a substantive annual allowance for capital gains. It makes no sense to put people off investment by immediately forcing them into the self-assessment tax system. £16,000 would be the allowance today if the 2020 level of £12,300 had been adjusted for inflation.

We are all familiar with this government’s 30% corporation tax hike, but the gradual upward path of dividend taxes receives less attention. A higher rate taxpayer currently pays 58.75% tax on corporate profits - 33.75% dividend tax on top of 25% corporation tax.

Britain has the 3rd highest taxes on corporate income in Europe. Back in 2016, dividend tax rates were considerably lower – 25% for higher rate taxpayers and zero for basic rate taxpayers. But successive supposedly conservative governments have hiked them bit by bit since then. Cutting corporation tax isn’t the only priority to boost growth - anti-investment dividend taxation is currently a killer.

Politicians have treated investors like a cash cow, but the more investment is taxed the less there will be of it. Other measures to encourage investment, as opposed to penalise it, would include increasing the tax-free ISA allowance for equity investment from £20,000, where it’s been stuck since 2017, to £40,000. Similarly investment into high-risk venture capital trusts and the enterprise investment scheme should be made more attractive by increasing income tax deductibility from 30% to 50%. 

Another way to make more capital available would be for the state to cease confiscating it from families on death. The death tax removes incentives to save and grow capital, stripping it from families to hand it to the state.

We should restore the pension dividend tax credit, foolishly removed by Gordon Brown in 1997. By 2014, it was estimated that savers had lost some £230bn as a result, money denied to our capital markets. This dealt a killer blow to UK capital markets and its pernicious effects continue year after year. Rather than trying to badger and cajole pension funds to invest more in the UK, ministers should stop penalising them.

Stamp duty, a pernicious 0.5% tax on share (not bond) purchases in UK markets, makes our markets both uncompetitive and more illiquid by providing an incentive to hold onto assets. The US has no stamp duty. Margaret Thatcher cut it from 2% in 1984. It’s time to zap it completely.

We need to protect Britain's private equity industry, which in 2022 invested £27.5bn in 1,600 British businesses. The “carried interest” tax rate should be reduced to 25% or lower to prevent the industry from being poached by European countries with lower tax rates.

The "windfall" tax on North Sea oil and gas should go. There is no windfall, just a desire by politicians to screw more money out of industry. Entirely predictably, it is leading to a huge decline in investment. Sir Jim Ratcliffe, owner of chemicals giant INEOS, accused the government of taxing the North Sea oil and gas industry “to death”. “Taxes are now so high”, he said, “that profits no longer fund future investments”.

Short-term thinking is killing investment

Politicians of all parties have increased the myriad taxes on investment to try and pay for their spending schemes. They have only succeeded in killing economic growth. Fuelling state spending is always seen as more important than sustaining investment, but if investment continues to decline and our capital markets dry up then the money won’t exist to pay for spending schemes.

The tax reforms proposed above will result in a reduction in state revenue in the short to medium term. But which is more important: Maintaining current state spending schemes, or enabling the economy to grow? This is the question that all chancellors must be forced to answer.