The tax reform debate is opportunistic, self-interested and ignores key issues

There are a lot of things wrong with the Australian tax system.  Weaknesses commonly identified include the imbalance in taxing powers between the Commonwealth and the States, excessive reliance on high marginal rates of income tax, a less than comprehensive income tax base, and the existence of a range of economically bad taxes (e.g. payroll tax, stamp duties, insurance taxes).

In the current tax debate most of these issues are not even being discussed, and the PM not long ago ruled out changes to the GST, if the Government gets re-elected.  [GST exclusions alone are estimated by Treasury to cost around $21 billion annually.  The GST itself raised $56 billion in 2014-15 suggesting the proposed 5 percentage point hike (that few wanted and is now dropped) would by itself have raised nearly $30 billion.]

All that remains is that the left side of politics (Labor/Greens) wants tax changes that reduce the scope for tax avoidance (by targeting tax concessions for superannuation, negative gearing and capital gains tax) by middle and high income earners (seen mainly as Liberal Party voters).  While the Government still says it wants to reduce current high marginal income tax rates, the reality is that there is no money to fund any substantive tax cuts (because the Budget deficit is already expected to come in at an unsustainable $37 billion this year). 

The Government does concede a need to address some tax loopholes, particularly superannuation tax shelters for high income earners, and (maybe) negative gearing on property investment.  It seems much less likely to address "concessional" taxation rates for capital gains.  Overall, any tax reform changes by the current Government seem certain to be modest.

The principle Labor is invoking to justify its tax proposals is one of taxing people based (at least in part) on their ability to pay, implying a belief that all forms of income should be captured within the tax net.  In this context it is worth canvassing the forms of income exempted from the tax net in order to see whether Labor's proposals truly address this issue.

The biggest exclusions from the tax net lie not in the areas identified by Labor. Instead the two biggest exclusions are (1) the tax exempt status of the imputed rent associated with owner-occupied housing, and (2) the exemption of owner-occupied housing from capital gains taxes.  While the removal of these particular loopholes (which exist in most countries) would be extremely difficult in political terms (and I am not necessarily supporting such policies), the fact is they represent truly huge tax shelters in monetary terms, they distort investment decisions by individuals, and they mainly benefit middle and high wealth individuals. 

In 2003 the Australian Housing and Urban Research Institute found that the tax concession of not taxing capital gains on owner-occupied housing was $13 billion in 2001, while the tax concession to owner-occupiers of not taxing imputed rent was estimated to be $8 billion annually.  Up-to-date figures would probably be several times these estimates in any translation to today's values.  Treasury has estimated that capital gains tax exemptions on the family home alone will cost the Budget well over $50 billion in 2015-16

We can conclude that Labor and the Greens are not truly serious about dealing comprehensively with all tax shelters for the better-off.  To be fair, the "sacred cow" of tax -exempt returns from the family home is accepted by both sides of politics. 

Let's now turn to tax concessions for negative gearing, capital gains, and superannuation   

Shadow Treasurer, Labor's Chris Bowen, reckons that "by the end of the decade, our changes to negative gearing and capital gains will deliver an annual $7 billion boon to the Budget bottom line, which will continue to grow until full maturity".  A Labor government would confine negative gearing to new housing from July 2017.  Current investments and any made before that date would be grandfathered.  Labor would also halve the capital gains discount for assets bought after July 1, 2017 – reducing the capital gains tax discount from the present 50 per cent to 25 per cent.

The problem with these proposals and their alleged revenue potential, is that they ignore the business model that drives negative gearing and capital gains. 

For negative gearing to pay off, the prerequisite is  a significant rate of asset price inflation.  If asset prices are not going up, there is little in the way of capital gains to be taxed.  Besides capital gains tax, real estate investment, in particular, is already subject to a range of taxes, including stamp duties, council rates, and land taxes.  In addition, substantial other transaction costs (e.g. legal and agents fees) are involved, and the banks now levy interest rate surcharges on investors. Pretty well the first eight per cent or so of any capital gain on property investments now goes in stamp duties and transaction costs.

In my view the days of high capital gains are largely behind us.

First of all, inflation and annual wage rises are now less than two per cent per annum compared  with up to 10 per cent and higher during parts of previous decades.  Secondly, big cuts in interest rates, which contributed to some of the rises in housing prices over the past decade, have largely run their course and could reverse.  The bottom line is that most experts don't expect much in the way of further capital appreciation in real estate (some are even spruiking a bust).  Sydney and Melbourne housing may well be over-priced, and the stock market has already experienced more capital losses than gains since 2008.  Also, Labor's proposals will themselves scare off many investors.  In short, I think Labor's prediction of "an annual $7 billion boon to the budget bottom line" from its proposed CGT and negative gearing measures is fanciful. 

Labor is also ignoring that capital gains tax is levied on nominal and not real capital gains, which is why they are taxed at a lower rate in most countries.  Lowering the CGT discount from 50 to 25 per cent may in many cases result in many taxpayers, who in reality had assets that barely kept pace with inflation, ending up with real after-tax capital losses.

On top of all this, politicians almost universally are ignoring the inequity in how capital losses are treated.  While capital gains are subject to income taxation, net capital losses can only be carried forward and claimed against future capital gains (which in some cases will never eventuate during the taxpayer's lifetime). 

It gets worse.  If a taxpayer does not pay an income tax bill straight away, the Australian Taxation Office hits them with a "general interest charge", which is currently an extortionate 9.22 per cent per annum.  On the other hand, if a taxpayer suffers an overall capital gains loss, the ATO does not pay any interest on the amount of tax overpaid (i.e. deferred tax benefit) so that this inequity in real terms compounds over time.  Given that investments like the stock market are on average still 25 per cent approximately below their pre-GFC peak, this is a major problem/inequity for some taxpayers.

In respect of superannuation, there is already broad consensus that, for those on high incomes, the tax breaks for superannuation are excessive, and there is broad support for some tightening for equity reasons.  Treasury has estimated that superannuation concessions cost almost $30 billion annually.  At least some (and probably the majority) of these concessions, however, are justified because those who self-fund their retirement (rather than relying on the Age Pension) deserve some reward.

More controversially, a subject rarely discussed is the 9.5 per cent of an employee's earnings that employers are required to contribute as part of the Superannuation Guarantee.  What is odd, is that employees, in cases where their only superannuation is that under the Superannuation Guarantee, are not required to also make a direct contribution themselves.  There is scope for all employees to be required to make a contribution of some sort from their wages (somewhat akin to national insurance or social security contributions that are mandatory in many developed countries) so that the burden of funding superannuation for the lower paid is shared more evenly between employers and workers. 

In terms of the Budget, there is also a problem that, for persons relying on the Superannuation Guarantee as their only form of superannuation, little or none of their (admittedly modest) superannuation payouts after retirement currently goes towards savings in age pension entitlements. In other words the Superannuation Guarantee is not bringing about the savings in age pension outlays that it ought to.  For a FULL age pension, a single person can have income (including superannuation) up to $4,212 a year, while a couple (combined) can have income up to $7,488 a year.  It will thus not be until entitlements from the Superannuation Guarantee build up further, that it will have much effect in reducing age pension outlays.

Overall, my take on the current tax reform debate is that it is almost entirely driven by partisan party politics, and people's responses are largely driven by self-interest.  Labor's proposals seem designed to present a pretence of dealing with the Budget deficit (through extravagant claims about the amount of revenue likely to be raised by their limited tax reform measures) while the Government's own efforts seem to be less than enthusiastic window-dressing.  None of the proposals currently on the table are likely to generate a lot of money so that our Budget deficit problem won't be greatly affected by either the Government's or Labor's proposals.

The basic issues that are yet to be addressed are excessive public spending and high rates of income taxation.  High marginal rates of income taxation provide the incentive for individuals to engage in tax avoidance (and tax evasion for that matter) in the first instance.  It is notable that an average full time employed adult male now falls into a tax bracket, where they are paying a marginal rate of 39 cents in the dollar (including levies).   This does not provide much incentive for work effort.  On the receiving end, fully HALF of Australian families now receive more in welfare than they pay in income tax, and we have seen a heap of new spending programmes (Gonski, NDIS, Innovation Package) in recent years without the prospect of revenue to pay for them. 

The reality is that all of this is not going to change anytime soon.