Treasury considering 33 per cent CGT discount ahead of budget

Treasury is reportedly modelling changes to the capital gains tax discount ahead of the May budget, with the current leading option being a reduction from 50 per cent to 33 per cent, The Australian Financial Review reported on Wednesday night (25 February).

Speaking on condition of anonymity, a source told the Financial Review that the government’s preferred proposal would not apply retrospectively or extend beyond housing.

The same source said they were concerned the changes would raise very little revenue, leaving little room to fund substantive tax reform. However, if applied retrospectively, the source estimated the change could raise $5 billion per year.

Over the course of this week, the Senate has heard a range of views on the CGT discount from stakeholders, including lobbyists, economists and tax specialists, as part of the Select Committee on the Operation of the Capital Gains Tax (CGT) Discount’s inquiry.

While stakeholders largely agreed that the discount overcompensated individuals for inflation, some argued that reducing the discount would disincentivise new housing supply and make Australia a less attractive target for global investors.

OECD economist Diana Hourani said that reducing the discount could have economic benefits, including positive impacts on equality, efficiency and government revenue. However, tax specialist David Montani warned that simply changing the discount in isolation constituted “tinkering” that would not fix fundamental issues with Australia’s tax system.

In a research note, policy think tank the e61 Institute modelled the economic consequences of different policies, including the CGT status quo, a 33 per cent discount, a return to cost base indexing, or an ‘ILT-neutral’ system that dampened the effects of inflation, leverage and timing.

The e61 Institute found that the broad-based CGT discount was generating significant horizontal inequality among Australia’s highest earners, and simply reducing the discount would not mitigate this issue.

Their modelling found that an ‘ILT-neutral system,’ which would include both cost base indexing and income averaging, would raise more revenue, reduce horizontal inequity and minimise behaviour distortions relating to timing.

It added that a return to cost base indexing, or the introduction of an ILT-neutral system, would remove the inflation incentive to borrow excessively to invest in CGT-generating assets.

Based on a simplified sample population, the modelling indicated that a 33 per cent discount would raise slightly more revenue than the 50 per cent discount, approximately $2.85 billion annually compared to $2.02 billion.

A more complex ILT-neutral income averaging system, or a return to pre-1999 cost base indexing, would respectively raise $3.52 billion and $3.41 billion per year.

While cost base indexing or an ILT-neutral system was preferable to broad-based discounts from an efficiency and equity perspective, the e61 Institute acknowledged that such measures could be costly and complex to carry out in practice.

“The ILT-neutral scenario provides an ideal for considering the taxation of these gains, but may be seen as complex or impractical – violating the principle of simplicity,” the researchers noted.

Such a system would require additional admin, including record-keeping of a taxpayer’s earnings history, interest costs and inflation experienced. However, it would more appropriately tax individuals based on their circumstances, addressing horizontal equity issues.

“The ILT-neutral system allows for the complexity of individual affairs – capturing information about earnings history, interest costs, and inflation experienced,” the researchers said.

“The difference between the median tax paid by age in the current system and the ILT-neutral system indicates that individuals in their 30s and early 40s have paid a higher tax rate than the ILT-neutral system, while retired Australians have paid a lower rate.”