Overview of poll results by Maria Yanotti
As the May budget approaches, the federal government is grappling with ways to enhance housing affordability, including considering proposals to reform the current 50% capital gains tax (CGT) deduction on property investment.
We polled ESA panellists on this question:
‘Capital gains tax deductions for housing investment should be removed because they overstimulate the housing market, contributing to rising house prices.’
This is a deliberately more extreme measure than the proposal reportedly being considered by the federal government, which is to cut the current discount to 25%.
But we wanted to assess more generally the effect of capital gains taxes on the housing market.
The poll found 44.4 percent of ESA poll respondents have agreed with a statement that the tax deduction should be removed entirely (22.2 percent agreeing and 22.2 percent strongly agreeing).
But 40.7 percent disagreed with the statement (22.2 percent disagreeing and 18.5 percent strongly disagreeing); 14.8 percent of respondents were uncertain.
Reading through the responses, it is likely that some panellists who voted against the statement might have agreed with the more specific propositions being assessed by the government - although not supportive of removing the CGT discount completely, they support decreasing it.
The capital gains tax (CGT) is calculated at the effective marginal tax rate of the investor on the nominal capital gains at the time of sale of the asset.
Investors who hold an asset for longer than 12 months receive a 50 percent discount on the CGT liability at the time of sale. For superannuation funds, the discount rate is 33.3 percent.
Owner-occupiers are fully exempt from capital gains tax on the sale of their primary residence.
Options reportedly being considered by the federal government include decreasing the CGT concession to 25 percent, decreasing it to 40 percent discount (as recommended in the Henry Tax Review) only for property investments, or some other reduction in the CGT discount for property investments.
Another option is completely removing the concession if the property is sold in the initial investment years; and phasing the discount in after the investment has been held for some specified number of years.
Arguments in favour
Supporters of the statement claim that the current CGT discount on nominal gains provides incentives to over-invest in property rather than other income-producing assets.
So by eliminating or reducing the CGT discount, the cost of capital will increase and buyers will reduce their demand for property, resulting in lower, more affordable house prices.
Critics argue any change in the CGT discount to address property speculation should also be accompanied by reforming negative gearing. Properties are deliberately leveraged so that interest payments and other expenses can be deducted at the full marginal rate.
Eliminating the CGT discount only for property will push residential investors towards cheaper leveraged properties or towards investing in other assets that maintain the CGT discount. This will also result in the negative gearing option being less attractive; after all, residential investors could offset the rental loss on the property (after negative gearing) with a profit on the sale of the property.
Most studies find no evidence of capital gains advantages being a main factor for investors holding residential property. However it appears to be a small factor in the intention of investing in residential property.
Those against the statement argue the timing may not be right as the housing cycle is currently at its peak, and the double digit house price appreciation rates are only seen in the inner-ring suburbs of metropolitan cities and only for houses and not apartments.
Economists would expect to see only a short-term drop in house prices if the CGT deductions are eliminated, as investors switch away from property and into other assets.
Residential investors remaining in the market will purchase cheaper properties, potentially further crowding out first-home buyers.
They would also hold the property for a longer period. In the medium to long-term, the reduction in residential investment will impact on the new/and existing supply of housing, resulting in housing shortage and rising house prices.
The debate becomes more complex when superannuation considerations are taken into account. Income earned in super funds (investment earnings) is taxed at a maximum rate of 15 percent. Capital gains earned over periods longer than 12 months within a super fund are taxed at 10 percent. Some self-managed superannuation funds (SMSF) are eligible for capital gains tax relief. From 1 July 2017 the Government is introducing some reforms.
These reforms will affect income stream transition to retirement (TTR) pensions which will lose the entitlement to tax-free investment earnings. All pensions being paid from a fund with more than $1.6 million will also lose that entitlement, and investment income will be taxed at 15 percent and capital gains at 10 percent. The reforms also include a special CGT relief concession for pensions currently in place. Decreasing the CGT deduction will reduce savings. Some are using family trusts and SMSF to buy property before the changes come through in July.
Summary of survey respondents:
While some economists support the current role of the CGT discount to avoid taxing inflationary gains as a component of capital gains (Saul Eslake, Rodney Maddock, Nigel Stapledon and Doug McTaggart), others believe the tax should apply to the real gains (Kevin Davis and Margaret Nowak).
Many argue that the principle of the CGT discount is not a bad policy, however the level of the discount is generous and is open for abuse.
They also pointed out that changes in one type of tax will distort the economy, especially if it is only targeted to one type of asset, property. The approach should be a holistic reform to fix tax inefficiencies, and tax treatment should be equalised between all forms of investment and saving – neutrality principle.
Most panellists agreed policies should be focused mainly on housing supply and housing market constraints (as well as transport and infrastructure) to solve the housing affordability crisis. Other policies such as shared-ownership schemes and government backed-bonds are also being considered.