On Britain’s Bubbling Capital Gains Tax Debate

How do you plug a £20 billion hole in the next fiscal year’s UK budget without raising income tax, national insurance contributions (NIC) or value-added tax (VAT)—or raising taxes at all on “working people”? This is the question plaguing new UK Chancellor of the Exchequer Rachel Reeves after her team purportedly identified a £20 billion gap between projected public spending and tax revenues next year. In a Bloomberg interview last week, she didn’t rule out a capital gains tax hike—putting the topic front and center. Several analysts are now penciling this into the Autumn Statement, and commentators are in overdrive warning it will hollow out the UK’s stock market. Yet the history of UK capital gains tax changes shows otherwise.

First, it is important to note a capital gains tax hike is entirely speculation at this point. We know Reeves didn’t rule it out, and we know Labour’s manifesto places only income taxes, NIC and VAT on the no-go list. Taxes on “working people,” too—and while we encounter many “working people” who own stocks, politicians often ignore that and act as if only fat cats invest. So we can see why everyone is running with this baton.

But the Autumn Statement is slated for October 30, over two and a half months away. A lot can change between now and then. Tax revenue could come in higher than expected, altering the deficit projections and easing the alleged “need” for changes. Reeves could also be floating a trial balloon to get the market’s and the public’s reaction—a time-honored tactic across both main political parties. Former Prime Minister (PM) Rishi Sunak was legendary for this as both PM and Chancellor. So were his predecessors at Nos. 10 and 11 Downing Street. Loose comments in an interview are hardly a policy blueprint, never mind actual legislation.

Still, it is possible. Currently, the UK’s tax rate on financial asset capital gains (e.g., stocks) is 10% or 20%, depending on one’s tax bracket. Some speculate Reeves could end preferential rates entirely, matching them to income tax rates (20%, 40% and 45%, depending on income level). Analysts cite some obvious drawbacks to this—not least of all, that capital gains aren’t indexed to inflation, raising the risk that higher rates turn a nominal gain into a post-tax, inflation-adjusted loss. They warn this will sap the incentive to invest, leaving households and UK stock markets poorer for it. Yet from April 1998, the UK went a decade with capital gains tax rates matching income tax rates and with no inflation adjustment—just a preferential rate for ultra-long holding periods. But the UK stock market didn’t implode. It participated in global cycles.

The UK’s capital gains tax rate history is short but telling. Until 1965, there was no capital gains tax. But this led to a lot of accounting skullduggery and asset shifting, leading the government to introduce a 30% capital gains tax that April. This predates the MSCI UK and MSCI World Indexes’ starting points. But other measures show UK stocks rising a bit in the year up to the change and jumping the year afterward, beating US stocks in the aftermath.^[i] It doesn’t seem to us that going from no taxes to 30% and no inflation adjustment made the UK suddenly uninvestible.

Exhibit 1 shows the full history after this: a description of each capital gains tax change, along with trailing and forward one-year returns for the MSCI UK Index, S&P 500 Index and MSCI World Index. As you will see, it is kind of all over the map. Indexing gains to inflation didn’t make UK stocks suddenly outperform in April 1982. Matching capital gains rates to income tax rates in 1988 didn’t make UK stocks suffer. Nor did scrapping the inflation adjustment in 1998. UK stocks’ returns the year after that are weak relative to the S&P 500, but they traded in line with the rest of Europe and those weak returns are more about the deep correction accompanying 1998’s Russian Ruble Crisis than anything local. And on the flipside, slashing the capital gains rate to a flat 18% in 2008 didn’t prevent UK stocks from falling hard in the bear market accompanying the global financial crisis.

Exhibit 1: A Brief History of UK Capital Gains Taxes and Returns

Source: UK Parliament and FactSet, as of 8/12/2024. MSCI UK price returns in GBP, S&P 500 price returns in USD and MSCI World price returns in USD.

Yes, a capital gains tax is a tax on investing, and the more you tax something, the less you get of it—in theory and all else equal. But theory isn’t reality, and all else is rarely equal. Taxes are but one variable affecting people’s investment decisions. Anticipated profits are another, tied to a host of factors, most of them global.

Hence, what we always point out when assessing taxes’ and politics’ market impact: Global swamps local. Global markets are highly correlated. You can see it in US and UK stocks’ parallel movements, even when their political backdrops diverge. You can see it in Europe, Australasia and North America moving from bull market to bear market and back again despite their disparate taxes, politics, trade policies, industry makeups and all the rest.

The UK is a value-heavy market with big exposure to Financials, Energy, Materials, Consumer Staples and Health Care. It has precious little Tech (or Tech-like industries in other sectors). This sector and style makeup will probably have a much larger influence on returns than tax tweaks, just as it has for decades. Index composition isn’t as exciting (or enraging) as taxes, so it doesn’t get headlines, but from a pure return standpoint, it tends to be far more meaningful.