Critics call tinkering with the capital gains tax discount a ‘thick as a brick’ policy idea and another second rate solution to solving our housing problem. What is the policy that would work?
I was asked by ABC Adelaide to look at the pros and cons of the discount on the capital gains tax (CGT). This is one item that looks to be targeted for a reduction in the May Budget, as Treasurer Jim Chalmers is being called upon to make some hard decisions to reduce the deficit and help the RBA beat inflation.
For those not in the know on this rule of the tax system, the 50% discount applies to the capital gains you make after holding the property, a share or other investments for a year or more. This encourages investors to hang on to their property to accumulate a gain that will be taxed at only half someone’s personal (or marginal) tax rate.
By the way, if the investment is bought inside a self-managed super fund and the asset is sold after the taxpayer has retired at age 60 or more, or is 65 years of age, the tax rate on sold assets is, wait for it, zero!
Away from super, and investors who borrow for their investment, get tax deductions on the interest of the loan as well. For highly paid wage earners, buying a property or stocks on credit can be very tax effective.
Left-wing inclined voters don’t like all this. And there are many other Aussies who think the attractiveness of the capital gains tax discount, on top of the tax deductions on borrowing, results in investors buying properties that first home buyers and other non-investors without a home should be getting. Fiscal experts say it’s a bad incentive creating intergenerational inequity, when older, well-off Australians benefit at the expense of the young and less wealthy.
Some will argue that these tax incentives hit the budget, reducing the revenue collected, which adds to the deficit.
On the flipside, there are those who argue that these incentives encourage investors to buy newly built properties that end up supplying renters with places to live in. The tax incentives for investors add to the supply of properties that governments used to provide so governments are no longer borrowing to build huge apartment blocks, and houses in outlying areas of capital cities. These properties were once called housing commission homes or public housing.
I suspect Jim Chalmers has been reading the room and thinks a majority aren’t investors in property. Many of those who are might not be Labor voters. He also has a group of academics and economists supporting changes to the capital gains tax discount. So, I thought I’d revisit an eye-opening piece in the AFR from former Treasury official, Geoff Francis.
Interestingly, the headline was: “Think the CGT discount is a tax break? Think again.” I’ll try and ‘dumb down’ his highly Treasury-like arguments. So here goes…
First, Francis says the 50% discount isn’t as good as you might think. I’ll get to that later.
Second, he argues the likes of NSW Treasury and the Grattan Institute have got it wrong bagging the discount. He says that even though investors compete with buyers at auctions (because investors don’t live in the property), they really add to the supply of housing available for renters. In fact, by providing rentable properties, it reduces the demand at auctions because renters have decided not to buy but to rent.
He also agrees that investors who buy off-the-plan add to the overall supply of properties.
He says higher tax slugs on investors will mean less dwellings are made. And our big immigration numbers, should push house prices up. (That immigration point is mine, not his.)
On taxing investors more to reduce house prices, he cites former Treasury economist Chris Richardson, who has done the calculations. Francis reports that “reducing the CGT discount to 33 per cent would lower prices by 1.5 to 2 per cent – the initial impact would be in the rental market with reduced supply of rental properties.”
What we’re talking about is a small fall in house prices but probably some big increases in rents. Those landlords who keep their properties have less tax benefits, but the demand for their properties would be rising because there are less rentable properties.
Francis looked at the current CGT regime and compared it to the one before. Then the cost base of the property was reduced for inflation so that only the real capital gain was taxed at the investor’s marginal tax rate. The old method could be good for an investor if inflation was pretty high, like it looks like it will be because of the Iran war.
The anti-CGT discount case weakens when you see this academic study that adjusts house price increases for the improvement costs that are embodied in house prices each year that Francis cites. “Academic studies (notably by Peter Abelson and Roselyne Joyeux, 2023) highlight that, when accounting for quality changes [to homes], real house prices have risen by about 50 per cent over the past two decades or about 2 per cent annual real growth. As inflation makes up more than half of nominal growth it implies the 50 per cent “discount” is no discount at all.”
Francis also makes the point that when middle income investors sell their investment property, they might get a discount, but the gain pushed them into the top tax bracket of 45% plus a 2% Medicare levy for that year.
Francis argues that tinkering with the CGT discount is a second-rate solution to the housing crisis that has failed our non-homeowners. He cites a former Treasury buddy who once told him: “As a nation, we seem willing to try every policy to solve the housing crisis other than that which is known to work.”
So, what is the policy that would work? Give incentives to builders/developers to build more homes! A start might be to reduce the tax slugs on developers by local councils, state government and, of course, the Federal Government, where Jim Chalmers controls the purse strings!
