Backbenchers' revolt succeeds in watering down reforms to CGT

A controversial rise in capital gains tax to pay for an increase in the income tax threshold will be announced in next week's Budget, David Cameron confirmed yesterday.

The coalition government's initial proposals to raise CGT from 18 per cent to 40 or even 50 per cent provoked uproar among Tory MPs who accused ministers of penalising savers. The Liberal Democrats had championed the proposal, which the party claimed would raise £1.9bn a year, as part of a package of plans to lift people earning less than £10,000 a year out of income tax.

But the Conservative backbench protests forced ministers into a rethink of the policy ahead of next Tuesday's Budget announcement by Chancellor George Osborne.

They are known to be considering a tapering system under which people who try to make quick profits are penalised, but those who hold long-term assets are not affected.

Mr Cameron insisted yesterday that the government had to act to stop many top earners trying to reduce their tax bill by receiving income in other forms than cash.

The Prime Minister confirmed that the Treasury believed more than £1bn was being lost to the Inland Revenue as a result.

"We are finding a lot of people turn income into capital in order to evade the tax system and we're losing over £1bn by that. So there's a problem we have to address," he told BBC Radio 2's Jeremy Vine show. "But I do not want to do anything that actually unfairly punishes savers – I don't want to go back to very high rates of marginal tax."

Mr Cameron confirmed that the Budget would include changes to CGT that yielded extra income for the Treasury – and that the cash would be used to raise the income tax threshold. It is likely that the government will only announce a slight increase in the current allowance of £6,475, but promise further progress towards £10,000 in subsequent years.

The Prime Minister said the Government planned to raise "some modest additional revenue" from CGT. It would be used to "fulfil one of the coalition's pledges, which is to lift the income tax threshold for all basic rate taxpayers, so you don't start paying income tax until a bit later."

He added: "I think that's a good thing to do to take poor people out of tax."

The Prime Minister reiterated that the Budget, which will set the Government's overall expenditure limits, and the spending review in the autumn, would contain unpalatable measures to reduce the national deficit and signalled that pay, public sector pensions and benefits would all be scrutinised for savings.

Earlier the Prime Minister had reassured Graham Brady, the chairman of the 1922 committee of Tory backbenchers, that the Budget would not punish savers. He said: "We have got to make sure that, in what we do, we help those who try to do the right thing, to save and to look after themselves and their families."

Mr Osborne confirmed last night that the government intended to press ahead with plans for a banking levy and would demand "further restraint" by the financial institutions on pay and bonuses. Details will be spelt out in the Budget.

Delivering the annual Mansion House speech, the Chancellor promised that the previous government's system for regulating the City would be dismantled.

The Financial Services Authority (FSA) will cease to exist in its current form and its regulatory powers handed to the Bank of England.

He disclosed that Hector Sants, who had announced his resignation as chief executive officer of the FSA four months ago, would remain after all to oversee the transition and become the first chief executive of the new regulator.

Mr Osborne said: "The plan I have set out tonight represents a new settlement between our banks and the rest of our society, a fairer settlement in which the banks support the people, instead of the people bailing out the banks."

He also announced the appointment of Sir John Vickers, former chief economist to the Bank of England, to chair a commission on the future of the banking industry.

Vince Cable, the Business Secretary, said: "The banking sector failed to deliver sustainable, balanced growth to the wider economy. Instead it acted as an agent for a massive increase in instability, the costs of which were unfairly borne by ordinary businesses and taxpayers."

Q&A: The rules

What is capital gains tax?

The tax paid on the profit from the sale of any asset, such as shares, land or property. It is currently charged at 18 per cent of profits above £10,100.

Who pays it?

Anyone who makes a profit on a second home, a buy-to-let property, shares or expensive items they inherit. Some windfalls are exempt, including cars, lottery and betting wins and stocks and shares in tax-free investment savings accounts, such as ISAs.

What is the problem?

Critics protest that the wealthy are often paid in the form of other goods to avoid being liable for the 40p or 50p top rates of tax. Typically they could receive shares, but there are other examples of employees receiving bonuses of expensive gifts rather than cash. They are tax-free if worth under £10,100 – and only taxed at 18 per cent above that level.

How much does it raise?

£8bn a year, depending on shifting property prices and volatility in the stock market. It is paid by about 130,000 people a year.

What did the Liberal Democrats propose?

Taxing capital gains "at the same rates as income" – in other words, at 40 per cent or 50 per cent. They calculated that the Treasury would raise an extra £1.92bn a year as a result.

What did the coalition suggest?

To tax "non-business capital gains at rates similar or close to those applied to income", with exemptions for entrepreneurs.

Why did many Tory MPs react in horror?

They fear that it could act as a disincentive to prudent savers – such as people who invest in second homes – and risk-taking entrepreneurs.

What could the compromise be?

Introducing a tapering scheme under which, for example, a rate of 30 per cent is imposed on gains over two years, 20 per cent for three years and 10 per cent for four years. There used to be a tapering system until 2008.

Nigel Morris