“Australia’s capital gains tax ‘discount’ is not a discount at all in a higher inflation environment, and can result in investors being taxed at rates exceeding 100 per cent on their real gains,” said Institute of Public Affairs Chief Economist Adam Creighton.
New research from the Institute of Public Affairs has found that Australia’s current capital gains tax (CGT) system, which applies a 50 per cent “discount” to nominal gains, can impose extremely high effective tax rates once inflation is properly accounted for. The analysis finds:
- When inflation exceeds roughly half the nominal rate of return, the current 50 per cent CGT discount produces higher effective tax rates than the previous indexation system.
- In a modern inflation scenario of 4 per cent per annum, even investment returns at 5 per cent would result in an effective tax rates on real gains approaching or exceeding 100 per cent, meaning investors are taxed on illusory gains.
- Reducing the CGT discount from 50 per cent to 33 per cent would significantly worsen these distortions, particularly in today’s higher inflation environment.
- The interaction of inflation and CGT is widely misunderstood, leading to persistent claims that the current system is overly generous.
“Much of the debate around capital gains tax is based on the mistaken belief that the 50 per cent discount represents a concession to investors,” Mr Creighton said.
“In reality, under even moderate inflation, the current system taxes both real and inflationary gains, which can result in extraordinarily high effective tax rates on genuine investment returns.”
“This means investors can lose virtually all of their real return to tax, despite appearing to make a nominal profit,” Mr Creighton said.
“Taxing purely inflationary gains is economically irrational. It discourages saving, distorts investment decisions, and undermines long-term capital formation.”
The IPA analysis also finds that the CGT indexation calculation method in force before 1999, which adjusted the cost base of assets for inflation, often produces lower and more economically coherent tax outcomes when inflation is elevated.
“Calls to reduce the CGT discount to 33 per cent would be a very poor reform,” Mr Creighton said.
“It would dramatically increase the extent to which Australians are taxed on gains that do not exist in real terms.”
The findings come amid growing debate about housing affordability and the role of tax policy in shaping investment decisions.
“Blaming the CGT discount for housing affordability challenges ignores the far more fundamental role of supply constraints, planning restrictions, and excessive taxation elsewhere in the economy,” Mr Creighton said.
“A tax system that penalises investment by taxing fictitious gains will only make Australia poorer over time.”
To download the IPA’s research click here.
