CGT trumps negative gearing

If England was a nation of shopkeepers as Napoleon is said to have asserted, modern Australia is a nation of landlords. The popularity of small-scale residential bricks-and-mortar investment, and the national obsession with the ups and downs of house prices, explains why negative gearing is such a hot button issue.

Negative gearing and capital gains tax concessions are often lumped together by the taxation hunters and gatherers, but they are vastly different beasts. There is little basis to attack negative gearing — which is simply an application of the principle that expenses incurred in earning income should be tax deductible — but even less to cut the capital gains discount. Increasing capital gains tax by half (by cutting the discount from 50% to 25%) would apply much more broadly than any change to negative gearing and be more damaging, but the objections are barely heard above the negative gearing commotion.

The principle that capital gains should not be taxed like recurrent income is recognised almost universally by discounts or lower tax rates, or in some cases by complete tax exemptions. Australia’s 50% discount is unexceptional.

It is often said that the Howard government, when it introduced the discount, ‘halved’ capital gains tax. It did nothing of the kind. It replaced indexation for inflation (effectively a discount in a different form) with a 50% discount, and abolished the averaging provision that reduced the effect of large, lumpy capital gains pushing taxpayers into higher tax brackets. The net effect relative to the previous regime was ambiguous, and in fact CGT revenue held up.

Cutting the discount to 25% would result in the harshest CGT regime Australia has ever had. The exact comparisons depend on rates of capital gain and inflation, but in many situations where the real return is low, the effective CGT rate would be higher with a 25% discount than it was under the indexation regime.

And those advocating a 25% discount are not advocating a return to the averaging provision to soften the blow.

Capital gains tax should be left alone, and the indications are that it will be in next week’s budget.