Articles – The Centre for Independent Studies

MEDIA RELEASE: Punitive tax on capital gains will hit growth

Michael Potter

01 March 2016

CISlogo-640x360The Labor Party should abandon its plans to impose a supertax on capital gains, according to Michael Potter, Research Fellow at the Centre for Independent Studies.

“The proposal to reduce the so-called ‘discount’ on capital gains to 25% will result in punitive tax rates on most assets. There is no justification for this tax penalty and the policy should be dumped,” Mr Potter said.

“The discussion around the proposal assumes that the Capital Gains Tax (CGT) discount is a tax concession.

“However, it is not: a discount of 25% will actually result in most capital gains being subject to punitive, additional tax compared to other income. The tax ‘concession’ will in fact be negative.

“If inflation stays around 2%, then every asset with a capital gain of less than 8% will be hit with a supertax under the proposed policy. It will be even worse if inflation increases above 2%.

“For example, if inflation reaches 3%, then for a taxpayer on $85,000 selling an asset with a capital gain of 4% per year, they will be slapped with a tax rate of 117%: the taxpayer will actually be losing money if they sell the asset. This is the type of supertax that is reserved for alcohol and cigarettes,” Mr Potter pointed out.

Detailed calculations of this example and others are in the table at the end of the media release.

“The extent of the supertax depends on the inflation rate. If inflation remains around 2%, then all assets with capital gains under 8% will be hit with a supertax. However, if inflation increases to 3%, then this threshold will be 12%. Every single asset with capital gains below 12% will be subject to the supertax.

“This penalty tax will apply to most assets. There are very few Apples and Googles on the market, in reality. For example, a report by AMP Capital has no asset class earning more than 8.3% over the decade to June 2015. Data from the Reserve Bank shows almost no postcodes in cities other than Perth having long-run house price growth above 8%. Over 70% of shares on the ASX had a yearly return of below 8%, as at Monday 29 February. And the recent large Sydney house price increases are unusual, not representing the rest of the country.

The effective tax rate of the proposal is shown in the graph below, for the cases where inflation is 2% or 3%.

“The proposal will result in Australia having the most onerous tax on capital it has ever had. The excessive tax rates will mean a large reduction in asset sales, slashing turnover in the housing market and the stock exchange.

“This supertax on capital gains runs completely counter to the view of many tax policy specialists that capital income — including capital gains — should actually be taxed at a lower rate than other income.

“Higher tax rates on capital will harm investment, which is already struggling to recover from the end of the mining boom. This in turn will cut economic growth, which is also sluggish at the moment.

“If the headline CGT discount is to be reduced, at the very least CGT indexation should be reintroduced, which would remove the overtaxation problem. However, it would be better for this policy for a punitive tax on capital gains to be abandoned,” Mr Potter said.

Michael Potter is a Research Fellow in the Economics program at the Centre for Independent Studies.

Calculation of effective tax rates under ALP’s proposed CGT changes

Calculation of effective tax rates for an individual with a personal marginal tax rate of 39%.

Asset with capital gain of 4% per year (before inflation)

Inflation rate Tax rate as % of asset value Nominal return after tax Real return before tax Real return after tax Effective Tax rate
2% 1.17% 2.83% 2% 0.83% 58.5%
3% 1.17% 2.83% 1% -0.17% 117.0%

 

Asset with capital gain of 6% per year (before inflation)

Inflation rate Tax rate as % of asset value Nominal return after tax Real return before tax Real return after tax Effective Tax rate
2% 1.76% 4.25% 4% 2.25% 43.9%
3% 1.76% 4.25% 3% 1.25% 58.5%

 

Calculation method:

Nominal return before tax = dollar value of return ÷ asset value

All other calculations below are in percentages

Tax rate as % of asset value = Nominal return x tax rate x (1- CGT discount)

Nominal return after tax = Nominal return – Tax rate as % of asset value

Real return before tax = Nominal return before tax – Inflation

Real return after tax = Nominal return after tax – Inflation

Effective tax rate (tax rate after inflation) = Tax rate as % of asset value ÷ Real return before tax

 

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