Never mind negative gearing – this is the real steal

Forget about the renewed hue and cry about negative gearing.

If the country wants a tax system that works, doesn’t distort investment decisions and could take some heat out of the property market, start with the concessional system of capital gains tax.

Forget the argument over negative gearing. The capital gains tax concession needs change.Credit:

The concession, put in place by Peter Costello in 1999, has become one of the key – if little debated – factors in the debate about property.

Paul Keating introduced the nation’s first capital gains tax in 1985 as part of a suite of measures that helped reduce the then-high rates of personal income tax on all working Australians.

Despite the Liberal Party vowing to repeal the tax at the 1987 election, it came to accept it as part of the tax system. But a Costello-commissioned review into business taxation argued that a tweak to capital gains would draw investment into the nation’s businesses via the share market.

By halving the rate of capital gains, it was expected to deliver a surge in productivity-enhancing investment. Instead, the cash flooded into the property market, supercharging price increases that have pushed every Australian capital city into the top 20 least affordable cities on the planet.

A landlord who lost money on their rental properties, thereby reducing their overall taxable income, could make up that loss by the concessional taxed capital gain that would come when they sold their investment.

This concession is now costing all taxpayers billions every year in foregone revenue.

The federal Treasury’s most recent annual tax expenditures report – which tracks how much revenue the federal government gives up with the concessions embedded in our tax system – revealed that in 2019-20 about $9.2 billion was foregone because of the CGT concession.

But by 2022-23, it had cost the federal government $25.3 billion.

What happened between 2019-20 and 2022-23? The biggest lift in house prices since the 1980s.

Property owners – including individuals and private trusts – sold up and cashed in through the tax system.

The foregone revenue was actually larger than the total value of rental deductions by both positively and negatively geared landlords.

More than 90 per cent of the benefit flowed to people with an above-median income and about 82 per cent went to those with incomes in the top 10 per cent of the nation. Those 10 per cent are going to find themselves in the top marginal tax rate, thus deriving the largest possible tax benefit from the concession on capital gains tax.

That’s not surprising. People with assets that attract capital gains tax are more likely to have the income to support the purchase of the assets in the first place.

One of the reasons to offer a concessional tax rate on capital gains is to ensure people are simply not taxed on a price increase due to inflation. The original Keating version indexed the value of an asset to inflation.

ANU tax expert Bob Breunig says the 50 per cent concession was based on the notion someone would hold an asset for about 10 years, with inflation averaging between 4 and 5 per cent over that decade.

Instead, inflation between 1995 and 2020 was much lower, delivering a tax windfall to asset owners.

All of this may be acceptable if all savings were treated the same. But they are not.

The Tax and Transfer Policy Institute at the Australian National University, in a paper released during the COVID pandemic, noted the wildly different ways that this country taxes savings.

Sink your savings into a home, there’s stamp duty on the purchase (a one-off impost) while the GST system treats a new house as a consumption good. After that, you’re effectively tax-free.

Rental income on an investment property, however, is caught up in the personal income tax system including the rules around negative gearing.

Hold that property for at least a year and then sell it, you qualify for that 50 per cent capital gains tax concession.

Superannuation has huge concessions aimed at encouraging us to save for our increasingly long retirements.

ANU tax expert Bob Breunig says the capital gains tax system encourages people to maximise their asset - and minimise their tax.Credit: Rhett Wyman

But if you have a savings account, such as someone trying to save for a deposit on a home, you get whacked your full marginal tax rate.

According to the institute, the marginal tax rate for a high-income earner can range from almost 100 per cent (on a rental property) to minus 40 per cent for superannuation. The marginal tax rate on someone with money in the bank savings is around 80 per cent.

As Breunig notes, people can delay when they sell an asset to later in life when they are wealthy but have next to zero-taxable income. Just another reason why Millennials and Zoomers often think the tax system is fixed against them.

Former Treasury economist Steven Hamilton recently noted in this masthead the current tax system distorts investment in favour of property, which was “clearly bad”.

Changes to the capital gains tax concession have been proposed since it became evident that the reforms from 1999 were not working as intended. Labor went to the 2019 election to reduce the concession to 25 per cent as part of the tax agenda the voters rejected.

Another option is to adopt a system in place in several countries already. Under a dual income tax system, the progressive tax rates on a person’s wages would remain as is.

All other income, including interest, capital gains and earnings within superannuation, would be taxed separately – probably at a single rate (for instance, 10 per cent or 25 per cent).

It’s simple to understand, fairer than the existing system, and reduces the distortionary way the current system prioritises property over other – and more productive – places for productivity-enhancing investment.

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