Will hiking CGT actually help younger Australians?

Hint: no

Intergenerational equity has become the word du jour in the lead up to the budget. So, in the name of “equity” the ALP plans to hike capital gains taxes on all asset classes.

Jim Chalmers has claimed that hiking CGT is the “right decision” done for the “right reasons”. Of course, one might be forgiven for wondering why they did not take such a decision to the election and why it is fine for a government to lie to get elected. But, let’s look at whether it even is the “right decision”.

The most frequently mentioned change is a reversion of CGT rates to the indexation method. This would adjust the capital base (i.e., purchase price, and presumably additional works) with inflation. The tax would then be on the real returns. It appears there will be partial grandfathering. Negative gearing also looks set to be eliminated.

There are several fundamental issues with the CGT hike.

It harms young people trying to save more than old people who already have

The first major issue is that the relative harm of such CGT hikes is on younger aspirational people, making claims of intergenerational equity inaccurate. This is for the simple reason that older people with more assets have already accrued wealth. In many cases, they will be positively geared and under no pressure to sell. By contrast, younger people must accrue assets. Thus, relative to their current level of wealth, younger people lose more from a CGT hike than older people who can ride it out.

The point is clear when we think about compounding, and simply how time works. Older Australians will have already saved under the old CGT regime. So, a 60 year old might well have had 20 years of the CGT discount. But, now a younger 20 year old, who is just starting in the work force, will face a higher CGT rate for the rest of their life. Superficially, politicians might claim that the older people lose most because they have wealth. But, the bigger losers are those who are no longer as able to build that wealth in the first place.

It applies to everything

In the lead up to the CGT hike, commentators had argued that tax settings exacerbated the housing crisis. I have argued elsewhere that this is not true. But, even if we assume it is, why is CGT increasing on stocks, which younger generations overwhelming use as investment vehicles? How is it that tax settings on shares in any way exacerbate the housing crisis?

Perverse incentives

A quirk of the mooted changes is that if the asset grows in line with inflation, then there are no capital gains. In this case, the earnings would come from levering the asset and/or yield. This creates a very perverse incentive. This is easiest to see with equities. It becomes disproportionately beneficial to invest in a “safe” ETF of blue chips paying fully franked dividends relative to a high risk startup or even a listed growth company.

To see this, consider an angel investor. He/she might invest in 10 companies in the hope of getting one breakout performer. Some of the 10 will go bankrupt. Some will meander. Some will do moderately well, possibly in line with the ASX. So much is clear from the IRRs of venture capital funds. Thus, it is clear that backing growth involves risk. So, suppose you get a 10x return on an investment, your $1 has grown to $10. Under the 50% discount scheme, you would pay $2.12 in tax if you are on the top marginal tax rate. However, under indexation, if inflation averages 3% pa, you will pay $4.07 in tax. The tax has nearly doubled. The effective tax rate in this case is 40.7% of the sale proceeds or 45% of the nominal gains of $9 (but 47% of the real gains). The difference is even more marked for an astounding 100x performance.

Compare this with investing $1 in a steady income ETF. Fully franked dividends attract a tax rate of approximately 17%. The ASX return varies significantly year-on-year. Let’s assume the return is 10% (which is on the high end, but is a round number). Then, after 10 years, the ETF is worth $2.59 in nominal terms. The capital base at 3% inflation is $1.33. So, the tax paid is 47% of $1.25 or $0.59. This means the tax is 22.7% of the sale proceeds, 37% of the nominal gains.

You see the problem: the effective tax rate on backing an innovative company is now higher than cruising on an ETF that pays fully franked dividends. This is the precise opposite of the type of incentive that would drive economic growth.

The bad incentives harm supply growth

The perverse incentives get worse. As is clear above, the effective tax rate from ‘cruising’ is lower than the effective tax rate from driving growth, which will now be higher than before.

How does this impact property? Badly.

Suppose a property investor buys an apartment for yield in the CBD. Well, CBD price growth is anemic-to-negative. But, there is solid yield. The capital growth might well be in line with inflation over the medium-to-long term. Thus, the capital gains tax rate is plausibly low.

Compare this with a tradie who buys a dilapidated house, renovates it in their spare time, and makes it livable. This can transform a $1m house to a $1.5m house. The tradie has now made $500k by investing their own sweat-equity. Suppose they sell after a year, they will be taxed on the real gain of around $470k, which will be at the highest tax rate that year.

You see the problem: the person who added to supply by improving a property, or potentially even by creating property, now faces a higher tax rate than the person who did not. This means that supply will not push higher.

It is also not obvious that higher CGT will push down property prices. Rather, we would just see a change in the investment model: buy existing property, sit on it forever, and derive yield. The, use the equity growth to borrow to buy the next property. Liquidity and supply would then both fall, which supports prices. Of course, price falls ought be avoided: It is not affordable or ‘equitable’ to push someone into negative equity by forcing down prices.

Australia is already on the wrong side of the Laffer curve

It is not obvious that hiking CGT rates results in more CGT tax receipts. This is due to the growth effect and international competition.

Australia’s CGT rates are already among the highest in the world, hitting at up to 47% of the capital gains. Compare this with New Zealand, UAE, Singapore, and Hong Kong, all of which are at 0%. The US has a long term discount and a highest marginal tax rate of 39%; many people will accrue earnings under a company, which has a rate of 21%. Vietnam – notably run by the Communist Party – scrapped CGT in 2025. China – also run by the Communist Party – has a CGT rate of 20%.

The United Kingdom hiked CGT rates from 18% to 24%; CGT receipts fell by between 10% and 18%, depending on the measure you look at, owing to a reduction in transaction volume and capital flight.

The net insight is that hiking CGT rates can, and will, result in structured capital flight. Just look at the UK. Investors are mobile and they have alternatives.

The net result

Hiking CGT, as the treasurer proposes, is not a solution to alleged “intergenerational equity”. It risks harming the very people it is supposed to help. One cannot help but wonder whether Jim Chalmers lied to the electorate in 2025 in order to pursue an ideological crusade against investors. And, knowing that the electorate might well see through the spin, wants to hike CGT without taking it to an election.