Hansard transcript: Robert Carling and Peter Tulip at Senate CGT Inquiry

 Robert Carling: Thank you for this opportunity. We are both researchers at the Centre for Independent Studies. Dr. Tulip has written and commented widely on housing issues and I have done so on capital gains tax more generally; and we will follow that division of labour in answering any questions you might have.  

And I might add that as there is no clear proposal on the table from government, we don’t know what we’re reacting to. So our comments will be broad and not confined to housing. So as well as the submission there have been three relevant research publications on capital gains tax issued by the CIS in 2009, 2015 and 2019 and perusal of those publications would make it clear to anybody that we do not think much of proposals to reduce the 50% discount.  

Now, if three publications looks like an obsession on our part, we have had a lot to say on the issue because calls for the discount to be cut or eliminated have been a persistent theme of tax policy debate ever since the defeat of the Howard government, which of course put the 50% discount in place in 1999.  

Along with superannuation concessions and negative gearing, the discount has been a favourite whipping boy. Cutting the discount is variously seen as a key plank of tax reform, a revenue raising measure, the key to lowering house prices, and a solution to intergenerational and vertical inequity. And our submission argues that it is none of those things or at least not in significant measure and that the 50% discount is justified. In brief, we make the following points.  

The principle of taxing nominal capital gains at lower rates than ordinary income is unexceptional and was recognized in Australia’s first model of capital gains tax in 1985. The 50% discount in 1999 replaced what was essentially a different form of discount in the 1985 model; based on indexing the cost base of assets to CPI inflation combined with an averaging scheme that limited the effect of lumpy capital gains pushing taxpayers into higher tax brackets.  

The pre-1999 arrangements produced a variable discount. But for average rates of return on assets and inflation rates and various asset holding periods, it can be demonstrated that the effective discount often fell in the 30 to 45% range and that is leaving aside the additional benefit of averaging that was available at that time. 

 So, the point is that the 50% discount, although it sounds enormous, is actually not much more generous than the average result of the policy it replaced. To those who say the 50% discount overcompensates for inflation, in some cases it does, and in some it doesn’t, or it even undercompensates.  

But the key point is that it was never intended solely to compensate for inflation. It was meant to be a general incentive for saving and investment which is needed now more than ever in light of stagnant productivity..  

On housing, several researchers have estimated the effect of cutting the discount would reduce house prices by a few percent while increasing rents in a similar amount. These effects are tiny relative to other influences on prices and rents and CGT affects much more in the investment world than just housing.So housing considerations alone should not drive broad CGT policy and carving out housing for a different treatment would be a step towards greater complexity. The claimed revenue costs of the discount, such as the $247 billion over 10 years that we’ve heard about, vastly overstate the revenue that could be gained from any reasonable or likely change. The claimed distribution of that revenue cost across income deciles is meaningless on close scrutiny and cutting the discount would barely move the dial on income and wealth distribution.  

Changing the CGT discount on its own is not tax reform, but it could have a place in broad tax reform that substantially reduces marginal rates and reforms the taxation of income from saving across the board. However, we don’t hear anybody in government talking about those kinds of options.  

We can expand on these points in response to your questions, but the key conclusion is that there is a very strong case for some form of tax concession for capital gains relative to full marginal rates.  

This concession should go beyond simply allowing for inflation. While various structures are possible to satisfy that condition, the current 50% discount — and don’t forget the one-third discount for superannuation funds — has the advantage of being simple, has been the basis for investment decisions over the past 26 years. So, it’s entrenched and it is well understood and there is no strong case for changing it. Thank you. 

Chair: Thanks, Mr. Carling… I wanted to start by asking: would you agree with the proposition that high house prices are a part of the housing challenge facing Australia? And if you do, or even if you don’t, would you accept that the capital gains tax discount has played a role in increasing demand and therefore increasing house prices in Australia?  

Peter Tulip: Yes, house prices are one of the worst social problems Australia is facing. Affordability typically rates the very top of opinion polls and voters concerns, for I think very sensible and understandable reasons. No one’s going to disagree with that.  

Removal of the CGT discount would reduce prices. There have been a number of research studies of the size of that effect. They all conclude that the effect is tiny if not trivial. I think the best single study was by some Melbourne University researchers, Cho, Li and Uren. They estimated that removal of the CGT discount would reduce house prices by just a trivial amount  — less than 1%  — while increasing rents by 1.3%.  

So, while affordability is a problem and lower prices are good, rents are a similarly important part of the overall affordability problem. And if you remove the capital gains discount, you increase rents. So overall the effect on affordability — it depends on how you weight prices and rents  — but many, many people, including me, would think that overall, you make affordability worse because you’re increasing rents with a really tiny effect. And I should say that’s the estimate by the Melbourne University researchers. Several other researchers have also looked at this, and they all conclude that the effect on prices is tiny. 

Chair: Dr. Tulip, you’ve spoken about your view that winding back or abolishing the CGT discount would have a — can’t remember the words you use but I think it’s fair to say trivial — but look 1 to 4% I mean on an average house price that could be tens of thousands of dollars could it not? Are you seriously going to look a working Australian who’s on $120,000 in the eye and tell them that a $40,000 saving on their home is trivial because it’s not, is it? That’s a significant saving is it not? 

Peter Tulip: That would take average house prices back to the level they were in October or September….  

Chair: Well, that’s right. That’s the scale of the problem  

Peter Tulip: …when we were facing when we were having exactly the same discussion about housing affordability. So, it would help, sure. But you’ve also got offsetting effects on rents that while you’re making prices more affordable, you’re making rents less affordable. So, the overall effect on affordability is ambiguous. 

Chair: Well, I’ll come to rents in a minute, but the New South Wales Treasury submission describes 1 to 4% as quote a material injection of demand. So, I mean, you might call it trivial. The New South Wales Treasury calls it material. I’m suggesting to you that a reduction in house prices of tens of thousands of dollars would not be trivial to someone who goes to work five days out of seven and is pulling home an average wage in Australia. That would be a significant reduction in the size of their mortgage, would it not? 

Peter Tulip: And I do not disagree with what you’ve just said there. But all of these things are relative. So, in terms of other government policies that are driving house prices, the effect of zoning regulations is adding 50… 60… 70% to the cost of houses. If you want to have a discussion about how government policy can improve housing affordability, let’s talk about planning. This CGT… I think there are equity issues and efficiency issues to do with it. It does not belong in a discussion of housing affordability. 

Chair: Okay. Although you do accept that it would assist with housing affordability if it were wound back. 

Peter Tulip: No, I don’t accept that. It will reduce prices but it’ll make rents worse. It’ll increase rents. 

Chair: All right. So, it’ll reduce prices. Come to rents now. We’ve heard from Saul Eslake this morning — very, might I say extremely, well-regarded independent economist in Australia. He says this: “contrary to oft assertions, purchases of established housing by investors do nothing to increase the net supply of rental housing because by outbidding prospective owner-occupier purchases, investors who purchase established dwellings are effectively increasing the demand for rental housing by the same amount as they are increasing the gross supply of it. Hence, any reduction in the CGT discount — and this goes to your point, Dr. Tulip — would not have any material impact on the supply of rental housing or on rents”. Dr. Eslake wrong about that, is he? 

Peter Tulip: I would like to see Dr. Eslake’s comments on the research results, where several papers have directly examined this question, trying to estimate it, and they find that a reduction in the CGT discount would increase rents. And okay, the effect is tiny. I think the best estimate out there is by the Melbourne University researchers I mentioned before which is just 1.3%. And I can completely understand how some people would say that’s not material because relative to the other government policies we talked about it really is swamped. If Dr. Eslake has critiques of the published estimates, we’d all be very interested to see them. I haven’t seen them. I haven’t seen Dr. Eslake’s estimates, so I can’t really criticize them. 

Chair: All right. No problems. I guess I’ll ask the question. Would you accept that if the CGT discount were reduced or removed or made less generous or removed, would that change the percentage of our housing stock that was owned by owner occupiers as opposed to property investors?  

Peter Tulip: Yes. We would have fewer renters and more owner-occupiers. I’ve not seen good credible estimates of the size of that effect. In contrast to estimates of prices and rents that we’ve seen, I think we can estimate those reliably. Changes in tenure are much harder to estimate, and I’ve not seen good estimates of the size of that.  

The idea that one in seven or one in eight renters might become an owner-occupier strikes me as just quite implausibly high. To buy a house in Australia at the moment, you need a deposit of $100,000 or $200,000. The renters I know do not have that much cash in their bank accounts. 

Chair: Yeah. Well, times are tough for many many millions of Australians, including overwhelmingly young Australians. And we have heard I might just go to the intergenerational elements. Now, we heard from Bill Kelty yesterday. I’m not sure if you saw his comments, but he described Australia’s current tax system as obscene and cruel because of its impacts and its well its unfairness towards young people. And he lumped the capital gains tax discount in as one of those unfair measures. So, I just want to put to you all … 4% of the benefit of the capital gains tax discount goes to people under 35. Now, that wouldn’t surprise anyone. As you move through life, you’re more able to or more likely to be able to afford to buy things that would appreciate in value. And when you sell them, of course, whether they be, you know, shares or real property, you can avail yourself of the capital gains tax discount. But it is, is it not? It’s an intergenerationally-inequitable tax discount given the almost non-existent proportion of the benefit that goes to young people. Would anyone take issue with that? Dr. Tulip. 

Peter Tulip: The big intergenerational distribution has gone to existing homeowners, and they have received enormous capital gains. So, it’s a question of whether, if you remove the discount, whether you make it retrospective. In the past, established taxation policy was to grandfather these changes. And if you do that, which in fact was Labor Party policy in the 2016 and 2019 elections, then you’re doing nothing to recoup those capital gains that the existing generation of old homeowners have made. So, you either grandfather this policy or you do something for intergenerational equity. You can’t do both. And existing policy has always been to grandfather these changes. So, it doesn’t do anything for intergenerational redistribution. The premise of Mr. Kelty’s question is exactly right. We have a terrible intergenerational problem because of the zoning restrictions which are locking young people out of the housing market. Fix that. The tax system won’t change it. 

Chair: Mr. Carling, just a general comment on these distributional issues. 

Robert Carling: Look, the tax system takes into account, or should take into account, issues of incentive or economic efficiency simplicity and equity. Okay, broadly speaking — and that’s for the system as a whole — it makes no sense to judge or dismiss any one tax or tax measure on the grounds that it doesn’t satisfy, it does not balance, all of those criteria appropriately. You need to look at the tax system as a whole. So, if you were concerned about equity alone, you wouldn’t have the GST or excise duties because they’re regressive. But they have a place in the whole tax system and the whole tax system has been very well demonstrated to be progressive; and the focus is always on how much capital gains tax is not paid because of the discount.  

So how about looking at the tax capital gains tax that actually is paid — and there is $31 billion of it this year. And if you did the same graph of the distribution of that across income deciles or age groups, you would find the same distribution as you do for the supposed revenue forgone as a result of the discount. So, the reality is that the capital gains tax as it is applied is highly progressive. It is highly progressive because the tax actually paid is heavily skewed towards higher income earners. 

 

 

Chair: Thank you. Mr. Carling. You’ve argued that the capital gains tax paid is progressive. But would you accept that the capital gains tax discount is regressive? 

Robert Carling: I think that with all the qualifications that attach to those estimates — I mean, I’ve seen figures going out 10 years — it’s hard enough to estimate what capital gains tax is going to be next year, let alone in 10 years’ time. But they also take no account of the fact that a lot of those people counted in the top income decile are there temporarily because of these big lumpy capital gains. So, the whole thing is circular. Also, those estimates don’t mean the government would gain that revenue from making a change, because they don’t make any allowance for the behavioural adjustment of the taxpayers. So, the revenue actually gained by making a change would be much less than those estimates of revenue foregone. 

Chair: Is that because you think there’d be a locking-in phenomenon where people might delay realizing capital gains until potentially their retirement when they’re in a lower tax bracket? 

Robert Carling: Yes, it’s partly that they would invest in different things. They would invest in shares with fully franked dividends and so on, especially if the CGT arrangements remain unchanged for shares and they change for housing. But also, to the point that you just mentioned that there is a powerful lock-in effect: the capital gains tax is essentially a turnover tax and if you tax it more heavily, you’ll get less turnover. People will hold on to what they’ve got for longer. 

Chair: That lumpiness that you mentioned, which is effectively that — as I understand it, and we’ve had evidence about this —when people realise the capital gain, that’s obviously treated as income, which bumps them up into a higher decile on the measurement scale. That’s what you’re referring to, is it Mr. Carling? 

Robert Carling: That’s what I’m referring to. Exactly. Yes. 

Chair: Accepting that, because obviously that is logical. But it’s not your contention, is it, that the capital gains tax discount doesn’t significantly bias towards wealthier or high income people? 

Robert Carling: No. I’m just saying that the graph that is displayed so often exaggerates the reality. 

Chair: Thanks. And Dr. Tulip, you mentioned that the current 50% concession is not much more generous than what it replaced which is indexation. But some would argue, would they not, that indexation of the treatment of capital gains is in fact itself quite a generous approach because we don’t index for example income tax. How would you respond to that? 

Peter Tulip: Robert, do you want to answer… that’s more a tax policy question?  

Robert Carling: Well, certainly when it was put in place in 1985, they took all those considerations into account and provided indexation anyway. Of course, the tax system is uneven in its treatment of inflation, but I think there’s a very powerful case for doing it in the return on assets. Because that is the income from those assets — the capital appreciation part of it, at least. There might be a recurrent income component also, such as rent or dividends and so on, in the case of shares. But the capital return is the whole appreciation. A major part of the total income from that asset is the capital appreciation. So, if you don’t allow for inflation in that, in many cases you would be taxing the gains in such a way that the real value of the asset would be shrinking. Put that way, it would be having that effect. 

Excuse me, Mr. Chairman. Could I just add very briefly to my answer on inflation in the tax system?  

Chair: Yes, you may, Mr. Carling.  

Robert Carling: That no organization has been stronger in its advocacy of indexation of income tax brackets than the CIS. 

Chair: Thanks Mr. Carling. Senator Dowling. 

Senator Dowling: Thank you, Chair. I think just this is all being looked at through the prism of housing. Obviously the CGT is much broader than that. But just to couple of points to clarify in the housing; some of you have argued that house prices are primarily structural supply constraints and that the CGT discount plays a very minor role in price formation. But then we’ve also argued that reducing the discount could significantly reduce rental supply and push up rent. So I’m just trying to understand that tension; that if it’s the concession’s too minor to materially affect purchase prices but what is the mechanism by which it can materially affect rental supply and rents because it can’t be small on one side and huge on the other. And also if you could just explain to me how the rental market works that landlords are able to just pass through any cost that they bear… because I would have thought it’s a function of supply and demand. And if landlords are able to just pass through any cost any additional cost, why wouldn’t they be doing that already? 

Peter Tulip: I would argue that the effect on both prices and rents is tiny. It’s trivial both ways.And the reason it increases rents: it’s not a pass through of costs; it’s because it discourages investment. So, you get less supply, and whenever you get less supply, prices go up. So you get an overall reduction in the supply of housing. But in particular you get a reduction in the supply of rental housing, partially offset by an increase in supply of owner-occupied housing. So that’s why prices fall and rents rise.   

Senator Dowling: In summary, it’s not a big deal either on either side. 

Peter Tulip: correct. 

Senator Dowling: Okay. Maybe one for Dr. Tulip, but feel free anyone else. That we have heard that around the introduction of the 50% discount in 1999, we saw an acceleration in house prices. And so, there’s obviously a correlation causation discussion there. But as I’ve asked others, we saw that similar trend in other jurisdictions around the world as well. US, UK, New Zealand. So, to what extent were there global factors going on versus CGT? And obviously Dr. Tulip, you’ve talked mainly about zoning being the primary driver, but was that also something that was relevant to the Australian market or that also drove those international price rises? 

Peter Tulip: The big thing that happened in that period was that world interest rates fell. And we know from very strong robust research in lots of different countries that interest rates have huge effects on house prices. So, you’ve got a reduction in mortgage rates, partly because real long-term interest rates fell, but also there was financial liberalisation. So for various reasons, mortgage rates fell all around the world for the same reason, and it had the same effect: pushing up prices. There’s no puzzle to be explained as to the increase in prices. The fall in interest rates explains it and— as you point out — the change in taxation arrangements was unique to Australia. So, the timing is clearly a coincidence. 

Senator Dowling: Yeah. Okay. Mr. Carling, in principle, do you have any issue with the way the discount system operated pre-1999; the 85 model that was just operated on indexation? What was wrong with that? Did it need to be changed? 

Robert Carling: First of all, it was more complicated and especially for people who have share investments and participate in dividend reinvestment plans. They end up with a long stream of small holdings and have to do the calculations for each holding based on quarterly CPIs. But secondly, that system was designed to tax 100% of real gains at people’s marginal rates. And I think that capital gains taxation should be more concessional than that. So, there’s a case for a concession beyond inflation in my view. There should be a concession going beyond just inflation adjustment. But I think the best thing about the pre-99 arrangements was the averaging provision, which everyone now seems to forget about but it was a great feature of those arrangements. 

Senator Dowling: So, do you think it’s an incorrect way to look at it; where people make this comparison of what people pay for their labour income and that they pay less on their capital gains. And that’s not a neutral way and we’re taxing labour higher than we’re taxing capital gains. You don’t think that’s the right, completely apples and oranges way…  to say well, if you have 50% discount on capital gains you should have 50% discount on wages? 

Robert Carling: They are apples and oranges. The capital gains are part of the return on capital. And wages are the total return on labour. And if you want to draw an analogy, then the appropriate thing to do to make an inflation adjustment for wages would be to automatically index the income tax bracket thresholds every year — which as I said, we have strongly advocated. But otherwise there’s no comparison between capital return and wage income. 

Chair: I believe we have Senator Bragg remotely. So, if you hear a disembodied voice, that will be Senator Bragg. Over to you, Senator Bragg. 

Senator Bragg: Thanks very much, Chair. So, I guess if there was a reduction in the concession what do you think would be the impact on rents on this? 

Peter Tulip: Well, I’m just going to repeat my previous answer from before you joined, Senator Bragg. I think the best available estimate is by several Melbourne University researchers who estimated that removal of the capital gains discount would increase rents by 1.3%. There have been several other studies all coming up with fairly similar estimates. Everyone that has done the numbers on this agrees that the effect is a small positive increase to rents. 

Senator Bragg: So, sounds like the view is that there would be slightly higher rents if the concession was to be reduced. I mean it also sounds to me that no one is saying this is the way to solve the housing crisis. So, I mean in politics, you know, people want to apportion blame or they like to link things or they like to say that ‘if I do this then I’ll get a particular result’. But it doesn’t sound to me that anyone thinks this would solve the housing crisis. 

Peter Tulip: I think it makes the crisis a bit better for owner-occupiers and it makes it worse for renters. So overall, I think many people would argue that this would make the overall housing crisis worse. 

Senator Bragg: Now, one of the other issues that might emerge if the government decides to progress this in some form will be that they would want to say that they’re going to use some of the revenue, which is currently forgone, for other purposes. But it would be good just to hear from you whether you think that revenue might be illusory. My sense is that just because it appears in the tax expenditure statement, it doesn’t mean that it’s money that can be spent on other things because it’s a tax expenditure. It’s not like a tax collection that you receive from an individual or a company. 

Peter Tulip: I think you can only use that revenue for other purposes in the next few years if you’re retrospectively taxing capital gains that have already occurred. If in contrast, you grandfather those tax increases the way most people have done — and the way the Labor Party proposed in the 2016 and 2019 elections — the revenue from this is tiny and it doesn’t allow you much spending for anything. 

Senator Bragg: So, it seems to me that there’s like a lot of arbitrage here. I mean, at the moment, mom and dad investors are incentivised to provide rental supply to other Australians. Some people think that’s cool, other people think it’s bad. But the government nonetheless have a whole agenda to support the idea of institutions engaging in providing properties for others to rent. Whether that be through the build-to-rent tax arrangements, whether that be through the changes that the treasurer is asking ASIC to look at through the disclosure arrangements, through RG97 — which I know that the property council and others have pushed. So, there appear to be a big push here to replace moms and dads with institutions. I mean, is there any evidence that moms and dads are bad landlords? 

Peter Tulip: There’s a lot. Australia has some of the worst rental insecurity in the OECD. We have more turnover of tenants and that turnover is disproportionately driven by landlords and that reflects the fact that we have the wrong landlords. That most of our rental stock is owned by mum and dad investors, as you mentioned, who only offer very short leases and they churn. I think the median rental property in Australia only lasts as a rental for five years. It’s more than double that in many European countries, because their rental stock is owned by large landlords who offer long-term leases and want the tenants to stay as long as they can. So yes, I think there is strong argument for preferring institutional landlords over mum and dad landlords.