Reducing the capital gains tax discount is an easy win. Why is the government ignoring it?

by John Daley and Danielle Wood

Published by The Guardian, Tuesday 26 April

In politics, as in life, easy wins are hard to come by. Which is why it comes as a surprise when a government in desperate search for ways to repair its budget, takes off the table a measure that could raise substantial revenue – $3.7bn a year – with minimal political pain.

Reducing the capital gains tax discount would be both good policy and good politics. But on Sunday the government announced it would not be making changes to capital gains tax on property or negative gearing in the May budget.

Our report released on Monday evening for the Grattan Institute, “Hot Property: negative gearing and capital gains tax reform” makes the policy case for change. The 50% capital gains tax discount means that the tax rate paid on capital gains is half the rate for other forms of income, such as wages.

There is a case to offer some discount – taxing gains at the full rate of income tax would mean taxing the component of investment returns that is simply due to inflation. But given actual returns, the 50% CGT discount has overcompensated many investors for inflation over the past 15 years.

Other policy considerations also push towards a lower discount. If taxes on capital gains are lower, then other more distorting taxes, such as taxes on labour income, need to be higher. Low taxes on capital gains encourage aggressive tax planning where people seek to reclassify labour income as capital gains to reduce their tax rate.

Generous tax concessions for investment also impose other costs on our society. In concert with negative gearing, the 50% capital gains tax discount encourages investors to seek out investments with high capital growth rather than annual income. It also provides an incentive for them to borrow as much as possible to fund those investments. Over the last 15 years, this has driven a boom in highly leveraged property investment. The Reserve Bank and Murray Financial System Inquiry have cautioned that these tax breaks contribute to volatility in the housing market, increasing Australia’s vulnerability to external shocks.

And like most tax concessions, large tax breaks for capital gains largely favour the well-off. In 2013-14, the top 10% of income earners received 67% of all capital gains income.

In an ideal world, policymakers would make changes to both capital gains tax discount and negative gearing. Our Hot Property Report recommends reducing the capital gains tax discount to 25%, so investors are taxed on 75% of their gains. We also advocate quarantining investment losses so they can only be written off against other investment income, not income from wages and salary. Deductions against salary income go beyond broadly accepted principles for offsetting losses against gains. No other developed country we could find, outside of New Zealand, allows such generous treatment for loss write-offs.

But the politics of changing capital gains tax seem to play very differently to the shrill debate that surrounds negative gearing. Australia’s love affair with negative geared property has made these tax breaks far more prominent in the public debate.

Almost all the media coverage of Labor’s housing affordability policy has focused on their proposed changes to negative gearing. A lot of the more silly claims about taking a “sledgehammer to property prices” and “soaring rents” have been tied to this aspect of the policy. The proposed capital gains tax changes, although far larger in dollar value, barely rate a mention in the coverage.

It doesn’t take a wonder political strategist to smell an opportunity. Moving to reduce the capital gains tax discount to 25% could raise $3.7bn a year for the budget with limited political pain. Whatever opprobrium it may attract would be muted by the fact that Labor’s policy goes further. And when even the Business Council and Property Council back some reduction in the discount, it really should be a no brainer.

So why would the government walk past this opportunity? There’s not too many tax increases that offer both minimal economic and political pain. Whatever the reason it’s hard not to be frustrated at another opportunity for good policy lost.