The income tax reforms in the 2026 budget do deliver greater equity, despite the protests from those who think they will lose out.
Immediately after the 2026-27 Budget was presented on 12 May, I described the tax reforms which were its centrepiece as “the most adventurous set of tax reforms seen so far this century”, albeit they were nowhere near as comprehensive as those introduced by Bob Hawke and Paul Keating in the mid-1980s, or by John Howard and Peter Costello in 2000.
I think that characterisation still stands, despite the evident difficulties the Government has encountered in ‘selling’ the Budget to the Australian public, in the face of trenchant opposition from those who perceive themselves as being adversely affected by it.
The fundamental question the tax changes proposed in the 2026-27 Budget seeks to address is, why should people earning the same income in different ways be treated differently by the income tax system?
Or, since how a question is framed can have a big impact on how it is answered, why should someone who earns, say, $100,000 in the form of wages and salaries – or, for that matter, interest – be expected to contribute more to the cost of providing teachers, doctors and nurses, police officers, and the broad range of services governments are expected to provide, than someone who earns $100,000 from capital gains, operating a business, trust distributions or other types of investment income?
I’m not arguing there should never be any differences between the way in which the tax system treats similar incomes earned through different channels. There are valid reasons why the tax system should, in some circumstances, treat similar incomes earned through different channels differently.
One of those reasons is that we are a capital-importing nation – one which, in all but six of the past 66 years hasn’t saved enough to fund all the investment we’ve wanted to undertake. So, we can’t completely ignore how the tax systems of other nations from which we seek to import capital treat different forms of income. And the fact is that the tax systems of most other ‘advanced’ nations do treat many forms of investment income differently (although not always more concessionally) than labour income.
That doesn’t mean we have to slavishly follow what other countries do. To take one example, New Zealand has a top marginal income tax rate of 39 per cent, and doesn’t levy tax on capital gains on assets held for more than two years. Yet that hasn’t resulted in a tidal wave of Australians moving to New Zealand. Indeed, there have been a lot of New Zealanders moving to Australia in recent years, despite our higher taxes on both high incomes and on capital gains.
Another plausible reason for taxing similar incomes earned in different ways differently may be to encourage some kinds of economic behaviour and discourage others – just as we use indirect taxes to discourage tobacco and excessive alcohol consumption. It may be appropriate to use the tax system to encourage additional saving (as we do with superannuation, for example) or particular types of investment or innovation.
Since the capital gains tax was first introduced in 1985, successive Australian governments of both political persuasions have wanted to prevent investors from being taxed on that part of any capital gain that merely compensates them for the impact of inflation on the real value of their investment. Between 1985 and 1999, that was done by indexing the cost base of an investment subject to capital gains tax by the CPI, so that only ‘real’ gains were taxed (at full marginal rates). Since 1999, capital gains have been taxed at half the rate otherwise applicable, without any specific allowance for inflation.
The system for taxing capital gains since 1999 has certainly meant less paperwork. But whether it has provided better protection for investors against the effect of inflation on the real value of their capital than the previous system –the one to which this year’s Budget seeks to return – in practice depends on whether the value of the asset has risen by more than twice the inflation rate over the period for which it has been held.
And, over the past 25 years, prices of detached houses have risen by more than double the inflation rate but prices of units, and of shares (as measured by the ASX All-Ordinaries index), have risen by less than double the inflation rate. So, the changes made in 1999 have, on average, reduced the amount of tax paid by property investors – in particular, those who have bought detached houses – but imposed higher capital gains tax on people who’ve invested in shares or units.
Is that what we want the tax system to encourage? What public benefit has been derived from providing incentives for people to borrow money in order to purchase residential properties that already exist – which is where over 80 per cent of the money borrowed for property investment goes – by allowing them to offset any excess of interest expense over rental income against their other income for tax purposes, and taxing any capital gains that they may make on such investments at half the rate applicable to wage and salary or interest income?
If making such investments less attractive after tax – or, as Angus Taylor and Tim Wilson would have it, “taxing them more” – means we “get less” of that form of investment, what’s not to like about that? Especially if, by retaining concessional tax treatment for investors who (unlike those who invest in established property) add to the supply of housing by purchasing, or financing the construction of, new housing?
Much has been made in the past two weeks of the allegedly unduly harsh impact of the Government’s proposed changes on young people seeking to accumulate a deposit on their first home by ‘rent-vesting’ – that is, acquiring a negatively geared investment property while renting themselves or continuing to live with their parents or by investing in crypto-currency or exchange-traded funds (ETFs).
Contrary to what’s been asserted by proponents of this view, there aren’t actually a lot of young people doing it. According to the most recent ATO Taxation Statistics (which are for 2022–23), only 4.3 per cent of taxpayers under the age of 35 report capital gains of any sort – and only 3 per cent of them are negatively-geared property investors.
What public benefit is derived by taxing those kinds of investments, in particular, crypto-currencies and ETFs, which track the US or other overseas stock market indices, more generously than those who seek to save up for a deposit in accounts at the financial institution they hope will one day grant them a housing loan?
Fatuous claims have also been widely made about the impact of the proposed CGT changes on businesses – in particular, the ludicrous assertion that they in effect make the government a 47 per cent shareholder in every business. That assertion ignores the fact that CGT only applies to the increase in the value of a business between its acquisition and its sale (less, from next year onwards, the allowance being made for the impact of inflation), not to the sale price. It likewise ignores the fact that the 47 per cent rate only applies to gains resulting in a taxable income of over $190,000, not to the entire gain.
Some self-styled ‘entrepreneurs’ are inviting people to believe that, if they start a business in the expectation of one day selling it for $1 billion (net of the tax they would have been liable for with the 50 per cent CGT discount), but would now only get (say) $800 million for it, they will have no incentive to start that business. Really?
There is a legitimate public policy interest in encouraging ‘start-ups’ – just as there is in encouraging investment in new housing, for which the Government has said it will retain negative gearing and the 50 per cent capital gains tax discount. But it would be wrong to confine any such provision for ‘start-ups’ to ‘tech’ businesses – not least because of the difficulty of defining what a ‘tech’ business is in a way that clever accountants and tax lawyers couldn’t drive a truck through. There should be a special provision for investors in ‘start-ups’ (and for employees of start-ups who receive shares in lieu of wages and salaries), since indexation of the cost base is of no value when the cost base is zero when an asset is initially acquired.
The Government should also re-think the application of the 30 per cent minimum tax rate on capital gains to taxpayers whose total taxable income is less than $45,000, and hence whose marginal tax rate is less than 30 per cent. There aren’t a lot of these – only 5.2 per cent of taxpayers with taxable incomes of less than $45,000 reported capital gains in 2022–23, and those capital gains represented less than 6 per cent of the total value of capital gains reported by all taxpayers. (Taxpayers in the top tax bracket accounted for almost 73 per cent of all capital gains reported in that year). A concession on that front wouldn’t cost a lot of money. And it’s no more right that people earning less than $45,000 in capital gains should be expected to pay more tax on those gains than someone earning the same amount in wages or salaries, than is the opposite.
The third key element of the Government’s proposed tax reforms is the proposed 30 per cent minimum tax on discretionary trust distributions. Like the proposed changes to the CGT system, this addresses the question, why should people who earn a given amount of income – in this case because they can structure their affairs through a trust – pay less tax on that income than someone who earns the same amount of income in wages or salaries (or interest)?
There are many legitimate reasons why people operating businesses may want to establish trusts – including providing for the orderly transfer of business assets from one generation to the next and shielding assets from vengeful ex-spouses or indigent children. But reducing tax shouldn’t be one of them – and in most other countries, it isn’t. Australia has over one million trusts – more in absolute terms than the UK, which has 835,000 of them, and far less relative to the size of our population than the US, which has three times as many trusts but 13 times as many people.
Ironically, when the Howard Government introduced the 50 per cent CGT discount in 1999, the quid pro quo with the Labor Opposition for its support was that trusts would be taxed as companies – a ‘deal’ which the Howard Government then ‘welshed’ on, under pressure from the National Party.
But the present government’s proposal addresses exactly the same question as the one I posed at the beginning of this article – why should people who are able to distribute their income to members of their family through trusts, thereby gaining access to multiple tax-free thresholds and lower marginal tax rates, pay less tax on any given amount of income than people who can’t, in particular, wage and salary earners?
To offer a personal example: since I stopped working for banks 11 years ago, I’ve been operating my little consultancy business through a trust and a company. I’ve been making a lot less money than I did when I worked for the Australian subsidiary of a Wall Street investment bank. But even if I was earning the same income – for the same amount of work, and with no greater risk – why should I be paying less tax on that income than when I was working for a bank?
And just because lots of small businesses have been operating through trusts for a long time, does that mean the tax concessions they derive as a result should be like the Biblical law of the Medes and the Persians, which altereth not? Particularly when set beside the plethora of other favourable tax treatment small businesses enjoy, including a company tax rate five percentage points lower than the one applying to larger businesses, exemptions from capital gains tax if their turnover is less than $2 million and their net assets less than $ 2 million, access to write-offs for capital expenditures not available to larger businesses, and exemptions from payroll tax?
The Government might have had a less challenging task ‘selling’ the reforms announced in the Budget if it had offered larger reductions in personal income tax, rather than saving those up until closer to the next election – although that might well have precluded them from foreshadowing a budget surplus by the middle of the 2030s, as this Budget did for the first time since 2019.
The Government would also be on firmer ground defending its proposed tax reforms as enhancing ‘equity’, if it wasn’t also giving Australia’s richest state, Western Australia,
$26 billion over the next four years. WA doesn’t need this to provide its population with a similar standard of public services, when it levies on them a similar level of state taxes as other states, and the transfer is on top of $29 billion already shovelled across the Nullarbor over the past seven years. That’s another promise the Government should never have made and should break if it wants its professed belief in promoting equity to be taken seriously.
Saul Eslake worked as an economist in the Australian financial markets for more than 25 years, including as Chief Economist at McIntosh Securities (a stockbroking firm) in the late 1980s, Chief Economist (International) at National Mutual Funds Management in the early 1990s, as Chief Economist at the Australia & New Zealand Banking Group (ANZ) from 1995 to 2009, and as Chief Economist (Australia & New Zealand) for Bank of America Merrill Lynch from 2011 until June 2015.