We Need to Talk About the Capital Gains Tax

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A removal of capital gains tax (CGT) discounts on homes worth over $2 million could add $12 billion to government coffers over the next four years. According to a new report from the Australia Institute, that figure could rise to $46 billion a year if the government cut back on all CGT discounts.

With the nation heading into a crunch election this year, tax reform will play a key role at the polls. But are capital gains what the government should be spending its time on? Or are they better off looking at other reforms, such as the goods and services tax (GST)?

Truth is there’s no better or worse option when it comes to tax reform. It always burns someone. Usually, wealthier Australians get the short end of the stick. After all, being a populist is always easier than catering to the rich. If a government can offend as few people as possible, they’ll always opt for that. Usually that means wealthier Aussies are the first port of call with any tax reform.

There’s little chance then that CGT discounts would go across the board. The government wouldn’t do that, as it’d irritate everyone, not just the wealthy. Even if such a move would cut the $40 billion budget deficit to zero in one year, it would amount to political suicide.

What the government would find more acceptable is hitting just the wealthy instead. For those who own homes worth over $2 million, the likelihood of that has gone up a notch.

Clearly, we’re not going to reduce the deficit by sitting around waiting for things to improve. The once in a lifetime mining boom is likely to be just that — once in a lifetime.

What the government has to figure out is how to best go about fixing the deficit. Or, rather, how to annoy as few people as possible while doing so.

Recent polls show voters remain opposed to GST hikes. So it might be more palatable to focus on capital gains instead. Any why not?

The exemptions on capital gains come at great cost to the government. More is spent on CGT discounts than on education, healthcare, or defence.

According to models by the University of Canberra, the top 20% of earners receive 55% of the benefits from CGT discounts. And the top 50% of earners receive 90% of all benefits. So there is clear scope for improvement in redressing this imbalance.

The chairman of AMP, Simon MeKeon, believes something has to give:

I really don’t understand why we give such a free kick to those in the community that are lucky enough to own very expensive homes that they live in.

There are plenty of homes, particularly in Sydney and Melbourne and Perth, that you just say, why should they be exempt?

As unpopular as it might be with some, there’s merit to cutting discounts for the wealthiest. Since its introduction in 1995, CGT exemptions have applied to all primary homes. These shouldn’t be confused with investment properties, where CGT still applies.

In the 20 years since it first came into law, who has benefitted most from it? Well, according to the Australia Institute, not low income earners.

Struggling households see few benefits from CGT discounts. Of the $46 billion the government hands out, most ends up in the hands of the wealthiest. That $46 billion figure is expected to grow out to $189 billion. And it will still be the wealthiest Aussies who benefit most from it.

It’s obvious then that this is a huge money sink for the government. Tens of billions are being spent on those that need help the least.

Looking at the CGT discounts, hiking the GST makes even less sense. While GST might be a more equitable tax, it’d hurt the neediest the most too. Since they already see few benefits from the CGT discounts, they’d be losing out all around.

By cutting CGT discounts for the wealthiest homeowners, there might be no need for GST reform. If it helped offset any GST hike, it would also benefit the economy. People would likely spend more in the event that GST tax remained as is. You’d get the best of both worlds. The budget deficit would come down, and economic activity would rise.

The effect of capital gains tax discounts on housing affordability

Another theory with CGT discounts is they make housing less affordable for everyday Aussies. Business groups seem to agree.

They say that the 50% capital gains discount, combined with negative gearing, could be contributing to property speculation. In turn, that speculation was doing little but adding to lower housing affordability. The Institute report highlights:

At present the exemption encourages over capitalisation in main residences since any increase in their value is tax free. This has the effect of pushing up the value of housing and therefore making that housing less affordable.

At the same time, the government would need to make some concessions here. If CGT discounts for the wealthy went the way of the dodo, it’d have no choice. By this I mean they’d have to take into account any potential loss on the sale of a home as well. Losing money on a sale should remain tax deductible. After all, the government can’t share in the spoils of a profit and just ignore the costs.

What happens next?

Tax reform is coming one way or another. This issue is likely to dominate public debate heading into the election this year. Whether it’s superannuation tax, negative gearing, GST or CGT, something will give way.

Ultimately, removing CGT discounts on homes worth at least $2 million is the lesser of many evils.

A change in the GST rate affects everyone. A CGT exemption cutback on Australia’s wealthiest hurt a smaller group by comparison. And it’s why the government is likely to give its support in the end.

Sometimes, the answer is as simple as that. Fairness and morality aside, governments make unpopular decisions when budgets are on the line, as the budget is now. But they also make sure it affects the fewest people as possible.

A GST hike might be the fairest tax proposal, but capital gains reform remains the likeliest.

Mat Spasic,

Junior Analyst, The Daily Reckoning

PS: Superannuation tax concessions are also on the chopping block. Like capital gains, the government is likely to consider cutting back on allowances for the rich.

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