When ‘25% off’ is not enough

Robert Carling

08 March 2019 | Ideas@TheCentre

Labor’s plans for negative gearing and dividend franking credit refunds have stirred up a hornet’s nest of controversy, but the plan to increase capital gains tax (CGT) 50% by halving the discount has largely escaped critical scrutiny.

To put the discount into perspective, there are numerous reasons not to tax capital gains in full — as outlined in my paper Myth vs reality: The case against increasing capital gains tax:

  • Part of nominal capital gains simply match inflation, and tax should only apply to real gains.
  • Realised capital gains are bunched, which may push taxpayers into higher marginal rate brackets than they would otherwise be in.
  • CGT has powerful disincentive effects on investment and saving.
  • The tax has a lock-in effect on asset holdings, which undermines capital market efficiency.
  • CGT represents ‘double taxation’ in some circumstances — the same reason as for the dividend imputation system.

The cost base indexation system of CGT that applied from 1985 to 1999 took care of the first item in this list and recognised the second by including an averaging provision. The 50% discount system that has applied since 1999 adjusts in an imprecise way for all items in the list.

In contrast, the proposed 25% discount would not even adjust fully for inflation in many situations, let alone for the other effects. Not just real gains but purely inflationary gains would be taxed, and the tax on real gains would be very high — up to 70% on average real share price gains, for example.

Rather than halve the discount, it would be better to either retain the 50% discount or — if the objective is to compensate for inflation in a precise way — restore cost base indexation as it applied up to 1999 but combine it with a smaller discount on real capital gains.

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