After last year’s federal election, I tried to look on the bright side: Perhaps a Labor government with a large majority might have the courage to simplify the tax system or slash federal spending, prioritising the nation’s long-term interests over the risk of losing a few far-left marginal seats in the capital cities.
Jim Chalmers’ fifth federal budget next week is likely to confirm, unfortunately, that nothing of the sort has or will happen any time soon, except in one intriguing case: capital gains tax.
It is possible that poor financial literacy among the left-wing commentariat could see the government actually improve the tax system, however modestly or accidentally. It appears poised to reform CGT in a way that could reduce rather than increase tax revenue.
For months Labor figures have been fuelling speculation the so-called CGT discount would be pared back, perhaps to 33 per cent from 50 per cent, as part of the government’s plan to “do something” about “intergenerational equity”.
Far from trimming an obviously unfair concession, such a policy would have led to a massive increase in tax, so it’s been pleasing to read speculation that the government won’t be doing that after all. It will instead, apparently, be reverting to an earlier method that taxed only real capital gains (after accounting for inflation) that was introduced by the Hawke government in 1985.
That would actually be an improvement over the prevailing and widely misunderstood CGT discount introduced by the Howard government in 1999, which has been accused of providing an unfair advantage to housing investors in particular.
Yet despite its name, the CGT discount is often not a discount at all compared to the previous indexation method, despite widespread perception that the earlier method was a tougher regime. Which is better depends on how well an investment has performed relative to the change in the CPI over the investment period. Obviously, the indexation strips out inflation, while the discount method taxes the entire nominal capital gain, albeit after applying a 50 per cent discount.
Intuitively, if inflation is high relative returns (specifically, if it makes up more than half the nominal gain), the previous 1985 system, which adjusted the purchase price for inflation, would offer the lower tax rate for investors. To be sure, the CGT discount represented a big reduction in tax for most investors when introduced in 1999. Back then, inflation hovered around 2 per cent, where it stayed until the Covid era. At the same time, major asset classes such as property and shares were belting out great returns, often above 10 per cent a year.
Even under those conditions, it wasn’t always better than indexation though, as IPA research recently illustrated. Consider the unfortunate investor who sold a typical investment property in late 2012 after holding it for five years, during which national dwelling prices gained 7.4 per cent while the CPI increased by 14.5 per cent. That seller would have made a significant real loss, yet still owed capital gains tax.
Under the indexation method, by contrast, he or she would have paid zero tax. Blue-chip ASX200 share investors who sold in June 2025 after four years would have faced a similar tax fate with stockmarket returns failing to keep pace with the CPI.
All this is why the speculation about a revival of indexation is puzzling, if promising. The sort of high-inflation environment we are entering would in fact make the prevailing “discount” more punishing than the old Hawke-Keating system. Moreover, asset prices are at record levels in many markets, potentially pointing to a period of weak nominal returns.
If the government is hoping to raise more revenue than it currently forecasts to raise from CGT, this is a very strange way to go about it. Whatever the theoretical merits of reviving a CGT that allows for inflation, doing so will do next to nothing to improve “housing affordability” or “intergenerational equity” – the two meaningless political goals of our age. Who wouldn’t want homes to be more affordable or generations to be treated more fairly?
Even the most partisan analyses suggest shifting the CGT rate would have a price impact on dwellings of a few per cent at most. New Zealand has had among the highest house price growth in the world in recent years without any capital gains tax at all. It is disappointing the government hasn’t adopted more creative tax reforms that could have increased revenue and housing supply, such as adopting a US-style step-up in basis.
In Australia, inheriting assets doesn’t trigger a change in the cost base to the time of the previous owner’s death, as it does in the US. This creates a capital gains “lock-in” effect at death that discourages families in Australia, for instance, from ever selling their assets, lest they trigger a CGT event that is massive.
Such a reform here could see a dramatic increase in the number of home sales that boosts housing supply and, in turn, possibly government revenues too. Alas, any such move would be seen as a sop to the rich, and so is unlikely to ever emerge.
