There’s been very little heard recently from supporters of tax reform in the government parties. But a trial balloon was floated in yesterday’s Age by Sophie Mirabella (formerly Sophie Panopoulos), described as an “influential federal Liberal backbencher”, concerning further restructuring and reduction of capital gains tax.

At present, most capital gains are discounted by 50% before being taxed, provided the asset has been held for at least 12 months. Under Mirabella’s plan, the discount would apply on a sliding scale, starting at 30% after 12 months but increasing to 70% after 10 years and 100% after 15 years.

Since most of the big money in capital gains is in assets that have been held for relatively long periods, it’s a fair bet that under this scheme most people would pay less tax rather than more. Indeed, despite the pro-forma nod to being “a disincentive for speculators”, it would be a step towards the goal of complete abolition of capital gains tax.

I’m all for lower taxes, but the differential treatment of capital gains makes no sense at all. Imagine, for example, three different ways I could make an extra $100,000:

(a) Work hard for a year, put in lots of overtime, and earn it in salary or wages;
(b) Have a good year on the sharemarket and earn it in capital gains; or
(c) Have a rich uncle die and leave it to me in hard cash.

Under our tax laws, (a) gets taxed at full value, (b) at a 50% discount, and (c) pays no tax at all. Yet on most people’s view, the social utility of the three options would run the other way around.

Having introduced a major distortion into the tax system by the discount on capital gains, the government is now being urged to remedy that by making it more complex and therefore more distorting. A better option would be to decide that income is income, regardless of where it comes from, so tax capital gains the same as any other income, and use the extra revenue to lower rates overall.

Mirabella and other supporters of reform have a valid point about the way capital gains tax discourages people from selling assets, particularly land. But that’s because it’s only imposed on sale: if the tax applied to all capital gains, whether realised or not, that distortion would disappear, with no loss in either revenue or fairness.

Peter Fray

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