Eamonn Butler: The Chancellor should cut CGT in his Budget. Higher rates have been counter-productive.

Dr Eamonn Butler is Director of the Adam Smith Institute. Follow Eamonn on Twitter.

The reason that Moody’s gave for downgrading the UK’s AAA status is that, although the Chancellor remains committed to sound public finances, there is precious little economic growth around to help him.

Quite simply, when you, or I or a government are deeply in debt, only two honest choices are available to us. We have to earn more or spend less.

Before this government was formed, many of us argued that there needed to be real and significant savings – what the BBC would call ‘deep cuts’ – in public expenditure. It would mean closing whole programmes, maybe even whole department, and focusing expenditure on only the top priorities.

But while politicians are very good at spending more, spending less does not come naturally to them. George Osborne figured that he could leave spending more or less unchanged, and that growth would rebalance the economy, leaving the state sector as a smaller, more affordable proportion of the whole. But that just hasn’t happened. Our customers in the US and EU are suffering, customers and businesses at home are sitting on their hands to see what happens, and people just aren’t making investments for the future.

We don’t need another spending splurge – that’s what got us into this mess. But we do need a growth agenda, and we need it now. We need to reduce the risks that are making people reluctant to invest. The key to that is to reduce workplace regulations and the taxes on business. The first, as Steve Hilton found, can be a tough job, given how many regulations come from the EU. But the second, we can do.

Apart from Vince Cable’s anti-business rhetoric (which hardly inspires confidence among employers), two of the stupidest moves by this coalition government were on the tax front: keeping their predecessor’s 50p tax (just timidly slicing just 5p off it) and raising capital gains tax on most things to 28%. We warned at the time that these were just envy taxes, and that neither would raise revenue for the Treasury – indeed, they would just drive business abroad. In the event, the income tax receipts show that clearly. But now the capital gains tax receipts are doing the same.

On 23 June 2010, CGT was raised from 18% to 28% for most taxpayers (there is a 10% ‘entrepreneurs’ rate to help people running businesses long-term). Unusually, the hike came in June, 78 days deep into the tax year – which is great for economists, who can see just what its effects in that tax year actually were.

And what occurred, of course, was a marked fall in revenues once the higher rate came in. On an annualised basis, the tax raised £8.2bn before 23 June, and just £3.3bn afterwards. Told you so.

Sure, some of this massive difference was down to people cashing in assets before the new tax hit (normal disposals were 76% down after 23 June, and even lower-rate disposals were down 34% as entrepreneurs sold off their lifetime businesses prior to being hit).

But that just shows that CGT is a voluntary tax. If people think the rate is too high, they just hold off selling assets until policy changes. The only people who are forced to sell assets and take the tax hit are people like elderly people who build up assets through their lifetimes and then need to fund their retirement, or episodes of medical or social care.

And people’s reluctance to volunteer for high rates of CGT is compounded by the fact that they know a large part of their ‘gain’ is in fact merely inflation. With inflation set to continue at morbid levels, they are likely to continue hanging on to their real assets rather than exchange them for evaporating cash.

Which is bad news for the Chancellor. Why did he ever listen to Vince Cable? But it is bad news too for business, and for the whole country. We need to make the UK an attractive place to do business in – and indeed, to make capital gains in. We need to make investors believe that we are really committed to low taxes and a cost-effective public sector. It’s time to end these counter-productively high rates.