MARK HUMPHERY-JENNER: Why capital gains tax changes unfair to young people

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.

Treasurer Jim Chalmers has claimed that hiking CGT is the “right decision” done for the “right reasons”. One might be forgiven for wondering why Labor did not take such a decision to the election, and why it is now apparently fine for a government to lie to get elected. But let us look at whether it even is the right decision.

The most frequently mentioned change is a reversion to the indexation method. This would adjust the capital base (that is, purchase price, and presumably additional works) with inflation, so tax would apply only on real returns. Partial grandfathering appears likely.

There are several fundamental problems with the CGT hike.

The relative harm of such CGT hikes falls on younger aspirational people, making claims of intergenerational equity inaccurate.

The reason is simple. Older people with substantial assets have already accrued their wealth under the old CGT regime. Many are positively geared and under no pressure to sell. By contrast, younger people must still accrue assets. A 20-year-old just starting in the workforce will face a higher CGT rate for the rest of their life. This worsens intergenerational equity.

Perverse incentives

A quirk of the mooted changes is that if an asset grows only in line with inflation, there are no capital gains. Earnings would come from leverage and/or yield. This creates a very perverse incentive: the worse you are at asset picking, the less tax you pay. It becomes disproportionately attractive to park money in a “safe” ETF of blue chips paying fully franked dividends rather than back a high-risk start-up or growth company.

Consider an angel investor. He or she might back 10 companies hoping for one breakout performer. Some will go bankrupt. It is high risk, but vital for economic growth. Suppose a $1 stake grows to $10. Under the 50 per cent discount scheme, the top marginal tax bill is $2.12. Under indexation, with 3 per cent inflation, the bill rises to $4.07 — nearly double. That is an effective tax of 40.7 per cent of the sale proceeds, or 45 per cent of the $9 nominal gain.

Now compare a $1 investment in a steady income ETF. Fully franked dividends attract roughly 17 per cent. Assume a 10 per cent ASX return (which is on the high end). After 10 years the holding is worth $2.59 in nominal terms, with a $1.33 inflation-adjusted base. Tax on sale is around $0.59 — 22.7 per cent of the sale proceeds, or 37 per cent of the nominal gain.

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

The bad incentives harm supply growth

The perverse incentives get worse — they disincentivise asset improvement and construction.

Suppose a property investor buys a CBD apartment for yield. CBD price growth is anaemic-to-negative, but the yield is solid. Capital growth tracks inflation over the medium term, so capital gains tax is plausibly low.

Compare this with a tradie who buys a dilapidated house, renovates it in their spare time, and turns a $1m property into a $1.5m one. The tradie has made $500k of sweat equity. Sell after a year and they are taxed on a real gain of about $470,000 at the top marginal rate.

You see the problem. The person who added to supply, either by improving a property, or potentially even creating property, now faces a higher tax rate than the one who did not. Supply will not push higher.

Australia’s CGT rates are already among the highest in the world, hitting up to 47 per cent of capital gains. Compare with New Zealand, the UAE, Singapore and Hong Kong, all at 0 per cent. The US has long-term discounts and a top marginal rate of 39 per cent, and many earnings flow through companies taxed at 21 per cent. Vietnam — run by the Communist Party — scrapped CGT in 2025. China — also run by the Communist Party — applies 20 per cent.

The United Kingdom recently hiked CGT from 18 per cent to 24 per cent; receipts fell by between 10 per cent and 18 per cent, depending on the measure, owing to lower transaction volumes and capital flight. The net insight: hiking CGT can, and will, drive structured capital flight, and will depress transaction volumes by incentivising “forever holds”.

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

Mark Humphery-Jenner is an associate professor of finance at UNSW