How capital gains tax changes could impact you

The softening-up process is in full swing.

Back in late 2024, as the federal election campaign was at its height, Treasurer Jim Chalmers ordered Treasury to run the numbers on the impact of scaling back some of the lucrative concessions to capital gains tax.

Somehow, this was leaked, paving the way for the treasurer to dismiss that anything was afoot.

Now, it's on again. This time, following another well-sourced leak, it could form the centrepiece of the next federal budget in May.

Once again, the idea, while not being absolutely ruled out, has been downplayed.

But, as the treasurer pointed out this week, generational inequality, arising mostly from soaring real estate prices, is a key focus of the federal government.

If there's one message to take out from this chain of events, it is that changes to the hugely favourable tax regime around real estate, which particularly benefit property investors, are coming.

But it might take longer than just the next few months, given the scars Labor still wears from the Coalition scare campaigns that kept it in the political wilderness in 2016 and 2019.

And if housing is the primary focus to ensure future generations can afford to put a roof over their heads, then the government may need to incorporate a broader policy that includes negative gearing.

Winding back welfare benefits is always a tricky business in politics, particularly when wealthy recipients view the handouts as a right rather than a rort.

Not just property

There's a common misconception about the discount on capital gains tax.

Most Australians believe it applies solely to real estate.

That's untrue. It applies to everything, to every investment you make, whether that be shares, businesses, bonds or even cryptocurrencies.

Normally, you pay capital gains tax at your top marginal rate on any profit you make from selling an investment.

But, if you hold that investment for longer than 12 months, you only pay tax on half the profit.

This was a change introduced by the Howard government in 1999, ostensibly to simplify the tax system after recommendations from the Ralph review into Australia's financial system.

The argument was that, given assets appreciate over time, because of inflation, you should only have to pay tax on the profits you've made over and above the inflation rate.

When Paul Keating introduced the Capital Gains Tax, he also recognised this principle, so that only gains above the official inflation rate were included when it came to tax.

The Ralph review deemed this to be too complex, arguing the changes would encourage investors to hold on to assets, especially shares, for longer periods and discourage the churn and burn strategies employed by some traders.

But in the 26 years since then-treasurer Peter Costello introduced the new "simplified" capital gains tax regime, asset price inflation has far outstripped consumer price inflation.

As a result, the changes have provided huge benefits to investors while denuding the federal government of revenue.

Throw that uniquely potent Australian version of negative gearing into the punchbowl, and little wonder the nation became drunk on real estate.

What about super?

There is far more at stake than real estate.

Scaling back capital gains tax discounts will impact investment right across the spectrum and will reach into our superannuation fund returns.

As a nation, we have more than $4.5 trillion in superannuation savings, much of it with an outsized exposure to the local stock market.

Changing the regime could alter investment patterns and returns, particularly in the short to medium term, something the treasurer no doubt would be working through now.

Getting that wrong would be an economic and political disaster.

But the argument for reforming the system is difficult to ignore.

If fairness is your benchmark, the current system is way out of whack with where the nation needs to be, and our self-perception as an egalitarian society.

The capital gains discount is likely to cost the nation about $21.8 billion this financial year, according to Treasury's latest tax expenditure statements.

That's calculated on the estimated amount of tax revenue foregone as a result of the policy being in place.

While more than a million Australians registered capital gains in 2022/23, the benefits overwhelmingly flowed through to the nation's richest

Treasury analysis estimates that those on the very highest income band enjoy more than 83 per cent of the financial windfall, highlighted in the graph below.

On a broader analysis, 95 per cent of the benefits accrue to those who earn more than the median income.

While the counterargument would be that wealthier people invest more, and hence have bigger capital gains, that's hardly a rationale for deliberately engineering a tax regime that transfers wealth to the wealthy.

All quiet on the negative gearing front

There's broad agreement as a nation that, when it comes to housing, drastic changes are required.

Our real estate is among the world's most expensive, which is no mean feat given our land mass and comparatively small population.

After 25 years of booming real estate prices, there's a yawning wealth gap, which has manifested initially as a generational divide, but which will become entrenched as a broader social problem if it continues.

Younger generations increasingly can only get a foot in the housing market if they inherit property or if their parents lend them the cash early.

Former Labor leader Bill Shorten's housing-fix proposal, to reduce the capital gains tax discount to 25 per cent, incorporated an important change to negative gearing as well.

The controversial tax arrangement — which allows property investors to write down their ordinary income by deducting operating losses on their real estate investments — was going to be allowed to remain in place.

But it could only be used to buy new property.

That would have provided an incentive for developers to boost housing supply. And it would have taken investors out of the arena when it came to competing with first home buyers for existing housing.

Would it have worked?

You only need to look back to 2017, when the banking regulator clamped down on lending to property investors.

They fled the housing market, and prices slipped.

Rather than a disaster, the breach was quickly filled. In the few years leading up to the pandemic, first home buyers dived in and outnumbered investors for the first time in years.