The cost of shrinking tax allowances

The past couple of years have seen plenty of headline tax changes.

Corporation tax up from 19% to 25%. National Insurance thresholds shifting. A freeze on income tax bands that's dragged millions into higher rates.

And running alongside those headline measures (but with far less fanfare) two allowances have been put on a crash diet that even Mounjaro would struggle to compete with.

The tax-free amounts for dividends and capital gains have both been cut by three-quarters in just two years.

That change alone has pulled over a million more people into paying these taxes. But the effect on the Treasury's take has been anything but straightforward.

Why? That's where the story gets strange.

What are these allowances?

The dividend allowance is the slice of dividend income you can receive each tax year without paying dividend tax. It only applies to investments held outside tax efficient accounts like ISAs and pensions. Above the allowance, your dividends are taxed at your applicable dividend rate.

The capital gains tax (CGT) allowance, meanwhile, works in a similar way: it's the amount of profit you can make when selling assets (like shares held outside an ISA, a second property, or other investments) before CGT kicks in.

Dividends: even the rubber duck looks concerned

Picture a mash-up of the last two Chancellors (if you can bear to imagine such a Frankenstein) crouched over the bath, twisting a sponge labelled "Investors' Dividends".

Jeremy Hunt, the former Chancellor, took the first two squeezes. The first sent out a satisfying gush of water. The second gave a reluctant trickle.

Now Rachel Reeves has inherited the sponge and is giving it a determined wring while cursing under her breath. "I'm sure there's more in here in somewhere."

In the corner, a rubber duck watches in silence. Its plastic expression says: this is getting awkward.

Back in 2016, the dividend allowance was £5,000. By 2018 it was down to £2,000. That figure held until April 2023, when it was halved to £1,000. April 2024 halved it again to £500, which is where it stayed in 2025. That's a 75% cut in just two years and a 90% cut since its peak.

The impact on who pays has been dramatic.

HMRC estimates the number of dividend taxpayers jumped from 1.9 million in 2022–23 to an estimated 3.67 million in 2024–25. That's 1.77 million extra people now sending the Treasury a slice of their payouts.

Many of those new entrants are in the basic-rate band, people who until recently didn't pay a penny in dividend tax. HMRC estimates 1.11 million basic-rate taxpayers will owe dividend tax for 2024/25.

So how much extra water is the Treasury collecting from this sponge?

Tax Year	Allowance	Dividend Tax Liabilities	% Change
2022–23	£2,000	£14.78 bn	–
2023–24	£1,000	£17.53 bn (proj.)	+18.6%
2024–25	£500	£18.28 bn (proj.)	+4.3%
2025–26	£500	£18.61 bn (proj.)	+1.8%

Overall, it's a 26% rise in receipts for a 75% cut in the allowance. But the last cut, a 50% drop from the previous limit and 90% if we look back to 2016's limits, barely delivered enough to wet the Chancellor's shoes – 1.8%.

These figures are estimated based on total tax liabilities each year, factoring in all variables, using the latest Survey of Personal Incomes data.

Meanwhile, by the Treasury's own reckoning, gutting the dividend allowance brought in £450 million in 2024/25 and will add £810 million in 2025/26.

Unlike the table above, these figures are policy-impact estimates. Basically, they're saying what they think the allowance cuts alone will raise compared with an imaginary world where the policy never happened but everything else is the same.

So, what's the takeaway on dividends?

The allowance cuts have sharply widened the tax net and brought in more revenue, but each reduction has delivered significantly smaller gains than the last.

CGT allowance down, revenue down

Now, let's turn our attention to capital gains tax, where a similar but slightly different story has unfolded.

The CGT allowance sat at £12,300 from 2020/21 to 2022/23 after rising from around £11,000 a decade earlier.

Then came the scalpel.

From April 2023 it was cut to £6,000 and from April 2024 it halved again to £3,000.

That's another 75% reduction in just two years, matching the scale of the dividend allowance squeeze.

You might imagine the Treasury would be inundated with revenue, and that the government's coffers would swell like Winnie the Pooh's honey pot after a particularly successful foraging trip.

In fact, CGT liabilities fell from roughly £17 billion in 2021/22 to £14.7 billion in 2022/23, and then slumped again to about £12.1 billion in 2023/24.

Tax year	CGT allowance (£)	Total CGT liabilities (£m)	% change in liabilities
2021–22	12,300	17,011	–
2022–23	12,300	14,653	-13.9%
2023–24	6,000	12,086	-17.5%

An 18% drop in a year when the allowance was already halved.

This data has already caused quite a buzz on social media, but what's actually going on here?

Before we can answer that question, indulge us as we take a transatlantic trip via your imagination.

The napkin that launched a thousand arguments

The year is 1974. The backdrop is a Washington DC restaurant. The protagonist is... a napkin?

Some napkins are destined to wipe burger grease from diners' lips. But once in a generation or so, there comes a napkin that finds itself at the centre of an economic theory.

Back in the 1970s, American economist Arthur Laffer sketched his now-famous curve on a restaurant napkin to make a point: raise taxes too far, and revenues can paradoxically start going down.

Why? Because people change their behaviour in response.

The curve starts at zero, because clearly if the tax rate is zero you won't collect any revenue. That's fine if you're a stretch of floodplain on the Croatian bank of the Danube, but not so fine if you've got a welfare state and army to run, and a national debt to pay interest on.

Revenue rises as you ratchet up the tax rate; that's obvious to everyone. But, according to Laffer's insight, revenue starts to fall once you pass a certain point.

In the short term, people shift investments abroad, defer sales, shuffle assets into tax wrappers, or find other ways to lower the bill.

In the longer term, higher rates can also dull the incentive to work, save, and invest, which slows economic growth; in turn, that means fewer profits being generated and less for the taxman to collect (despite him taking a bigger percentage).

Everyone makes less money as a result.

And is this curve in the room with us right now?

Critics argue that even if tax revenue really does follow the neat arc Arthur Laffer sketched on that famous napkin, it's not much use for policymaking. After all, no one can say with certainty where we are on the curve at any given moment.

It's a bit like Plato's theory of the cave: we catch glimpses of shadows on the wall, but the full shape of the curve is hidden from view.

Still, the latest CGT figures could lead some to believe that on capital gains allowances, we're heading down the wrong side of the Laffer curve.

The allowance went down, and so did total CGT liabilities.

But then again, maybe not.

Much of the 2023/24 shortfall can be explained by timing.

Many investors and property owners "banked" their gains while the £12,300 exemption was still alive, selling up in 2021/22 and 2022/23 to lock in tax-free profits. That front-loading helped make 2021/22 a record CGT year at over £17 billion, but it left slim pickings for 2023/24.

HMRC even notes the number of CGT payers edged up by 1% to about 378,000 in 2023/24, thanks to those with modest gains between £6,000 and £12,000 now being dragged into the net.

However, the big-ticket disposals (the ones that account for the lion's share of the revenue) largely vanished.

It's worth noting that those with gains of £5 million or more make up close to half of all the CGT raised (even in 2023/24).

In other words, the drop may not actually be a sign that we're on the wrong side of the Laffer curve. That would require enough potential taxpayers to find ways to permanently avoid HMRC's reach so that the total take stayed below pre-allowance change levels.

Instead, it could just be the aftershock of a temporary rush to cash in while the higher exemption was still on offer.

If that's the case, the numbers might recover once those who postponed selling can't hold off any longer.

To judge a change like this accurately, a number of years must pass first.

So, what is the cost of shrinking allowances?

• Dividends: The allowance has been cut by 75% in two years, pulling an extra 1.77 million people into paying dividend tax. Revenue has risen, but each cut has delivered smaller gains as investors adapt.
• Capital gains: The allowance has also been cut by 75%, but receipts fell 18% in the first year, largely due to investors selling early to use the higher exemption. HMRC expects revenues to recover as deferred sales eventually go through, although for now hushed whispers of the Laffer curve linger in the back of Treasury civil servants' minds.

Sympathy for the devil: why HMRC is doing this

From the Treasury's point of view, the logic for increasing these taxes goes something like this:

• There's a big post-pandemic hole in the public finances, and slicing back the capital gains and dividend allowances is a way of plugging some of it without hiking basic-rate income tax. The official projections estimate the two cuts together should bring in about £1.2 billion a year.
• Only a minority of the population is affected: 378,000 people paid CGT in 2023/24 (about 1% of all income tax payers); meanwhile, only 3.67 million people paid dividend tax in 2024/25.
• They'll also say it's about fairness. Fat allowances made it easier to shuffle income into dividends or capital gains and pay less tax than someone earning the same in salary. Lowering the thresholds closes that gap and reduces the appeal of those tricks.
• From an international perspective, the UK's old CGT allowance was generous by global standards, with plenty of countries offering little or no annual exemption. A logical counterpoint to this would be that the UK has to offer some perks – we can't strip everything away otherwise other countries become more appealing to move to.
• Anyone with modest holdings can still hide them away in ISAs or pensions. Those sitting on portfolios that are too big to shelter in this way arguably have broad enough shoulders to take the burden.

Bottom line

The dividend allowance is down 75% in two years, pulling 1.77 million extra people into the tax net and adding £450 million in 2024/25. But the yield from each cut is shrinking fast, from an 18.6% jump in receipts after the first squeeze to barely 1.8% after the last.

The matching cut in capital gains tax has yet to deliver, with receipts falling 18% in year one as gains were cashed in early. The Treasury is betting the numbers will bounce back once those deferred sales land.

The Treasury says it's about fairness and raising money from those who can afford it. Critics will keep waving Laffer's napkin and asking if we're already paying too much.

The thing is... these aren't the only tax increases affecting people in the UK. We're being hit from every angle. Some of these taxes aren't even visible. For more on stealth taxes, watch this excellent video on Damien Talks Money:

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