Reducing the discount would likely not have any lasting impact in lowering house prices

Anyone watching the smoke signals from Canberra knows that moves are afoot to try and increase capital gains tax (aka ‘cut the discount’). 

A Greens-led Senate inquiry has been stoking the ‘national conversation’ that Treasurer Jim Chalmers wants to promote about the details.       

Now we can see where this sort of conversation could go in Chalmers’ May budget thanks to last week’s tax plan from Sydney Teal MP Allegra Spender, and the release this week of the report of the Senate Committee tasked with reviewing the capital gains tax discount.  

It is not surprising that an inquiry spearheaded by the Greens would enthuse about the alleged benefits of cutting the 50% CGT discount, especially for investor housing.  

The problem is that the focus on capital gains tax is narrow and the conversation one-sided. It is a group-think exercise propagating myths and over-blown claims and dismissive of any suggestion that the current capital gains tax settings are justified. 

The current system is built on the widely accepted principle that capital gains should not be taxed the same as ordinary income. It is a principle observed in many other countries and it was observed in the design of Australia’s first comprehensive capital gains tax in 1985.  

The version put in place by the Howard government in 1999 allows a 50% discount of gains on disposals of assets held for more than 12 months.  

This replaced the 1985–1999 indexation system that exempted purely inflationary gains from taxation and allowed averaging to limit the impact of lumpy capital gains on individuals’ average tax rates.  

On close inspection, the 50% discount, on average, results in tax burdens not much less than the indexation plus averaging system. That is, the discount is not that generous.    

Costello’s 1999 change was intended as a simplification; not only to compensate for inflation but also to provide a broad, neutral incentive for all forms of saving and investment. 

House prices were not prominent in the debate about capital gains then as they are now, but the evidence is that any capital gains tax concession has contributed little to house price growth.  

Reducing the discount would likely not have any material, lasting impact in lowering house prices.  

Further, capital gains tax covers all types of assets and should not be driven by housing alone. 

Nor is there any merit to claims that higher income earners reap most of the benefit of the capital gains tax discount. 

 Rather than any one tax or transfer, it is the tax/transfer system as a whole that matters to distribution. Australia’s system is highly redistributive from higher to lower incomes. 

Fiddling with capital gains tax as suggested would hardly shift the dial of income or wealth distribution. 

The tax revenue gains from any reasonable change to capital gains tax would be nothing like the $247 billion in revenue foregone claimed by the Greens.  

This is a gross exaggeration of a 10-year guesstimate of an extreme policy — taxing 100% of nominal capital gains. It takes no account of the behavioural responses by investors that would limit the revenue actually gained from such a policy change. 

All of the cuts to the discount that have been floated — to 33%, 30% or 25%  — would result in hefty increases in tax payable on a given transaction. Halving the discount to 25%, for example, would increase tax payable by at least 50%. 

Such a large tax increase would surely cause people to change their saving and investing decisions — and not in a way conducive to boosting productivity growth.  

The campaign to increase capital gains tax pays no regard to the importance of saving and investing; and to capital gain being part of the reward. 

Changing capital gains tax on its own is not reform, but it may have a part to play in a broad tax reform package that lowers marginal tax rates for wage and salary earners.  

Spender’s proposal is one example of a broader reform package. However, her plan would cut each marginal personal income tax rate by only 2.5 percentage points. The current rates — 16%, 30%, 37% and 45% (plus the 2% Medicare levy) — would therefore fall only slightly. Under her plan, the top marginal tax rate would drop from 45% to just 42.5%. 

Savers and investors would be hit hard to pay for it through a range of measures, including a cut in the capital gains discount to only 30%.  But the benefit to wage earners would be more modest.   

Spender offers no reduction to the internationally-uncompetitive 30% company tax, nor anything to fix bracket creep, which would gobble up her tax cuts within a few years. 

The result of this is a zero-sum package that hits investors’ capital income hard, while not delivering enough benefit to wage earners suffering from inflationary tax bracket creep. 

Robbing Peter to pay Paul might fit some peoples’ notion of equity, but it takes no account of how Peter would respond, which is likely to outweigh any broad economic benefit from sharpening the incentive to work.  

Spender admirably constrained herself to a package that would not increase the looming decade of budget deficits. But this just draws attention to the fact that broad tax reform with few losers would require Chalmers to make a serious effort to reduce government spending.        

 

Robert Carling is a Senior Fellow, and Michael Stutchbury is Executive Director, at the Centre for Independent Studies.