Real reform to nation’s tax system? Get real

The Australian

18 February 2017

Terry McCrann

Policy rationality forced the Treasurer — and the Prime Minister? — to put the reduction of tax incentives for property investment on the table. Political reality forced the Finance Minister — and PM? — to then immediately sweep them off.

I put a question mark over the PM’s role because the events of the last week indicated we were back to the ‘old Malcolm’ of — if putting it positively — being open-minded and even, dare I say it, innovative; but putting it less kindly, of discursiveness and outright ramble. So who knows: was he a co-driver or merely a facilitator?

Just as elections have consequences, as so many across the Pacific are finding out, and none more shockingly than the panjandrums of the far left wing, so-called, mainstream media of the three TV networks, CNN, The Washington Post and especially The New York Times, so also do policy decisions.

When the government decided to increase the taxation of superannuation it really had no option in policy logic but to also reduce the tax incentives for investment in property.

Now we can argue over ‘tax purity’ until either hell or the earth freezes over — the latter, presumably as the inevitable consequence of global warming — or we can recognise that the only ‘purity’ in our tax, indeed in any tax, system, is that it is inevitably and irresistibly riddled with impurity.

There are of course two big incentives enjoyed by property investment: the ability to ‘negatively gear’ — to deliberately generate operating expenses, mostly via interest, greater than income; to then deduct the net loss against other taxable income, usually wages and salaries; and the way realised capital gains are taxed.

Now one side reasonably argues that the deduction of losses from one activity against other income is the most basic feature of entity taxation. While taxing only 50 per cent of the gross capital gain just as reasonably aims to avoid the inequity of taxing both real and nominal gains.

Indeed, it specifically replaced the mechanism put in place by the CGT creator, then-treasurer Paul Keating, of deducting nominal gains by use of the CPI, to only tax real gains.

The other side can argue that the exact application of the form of entity tax is also reasonably up for grabs. As is the choice of taxing 50 per cent of the gross (real plus nominal) gain.
These things are not some mandate of (the real) heaven. It would not offend tax logic for a government to, say, limit the cross-income deductibility, to, say, two properties. Or three. Or to limit the amount of current expense deduction to income specifically earned by that property, with any excess to be carried forward for later deduction.

Similarly, it would not offend either logic or equity to increase the tax on the gain from 50 to 70 or the 75 per cent purportedly proposed. All these things are a matter of legitimate choice.

And arguably, it was a choice that needed to be exercised. By increasing the taxation of super, the government will further encourage investment in both investment — taxable income generating — property and the family home.

Their after-tax and net social welfare appeal has been significantly enhanced.

We already dramatically over-invest in residential property. It seems the ultimate no-brainer: the negative-gearing allows you to both significantly lift the size of your

investment while also having the taxpayer reduce your running cost. Then when you sell you get to keep almost certainly all the nominal increase in value and quite probably a significant portion of the real increase as well.

As opposed to, I might note, the way all the increase in both your real and nominal income is punitively taxed, thanks to the absence of scale indexation and the progressive tax scale.

So by increasing the tax on super, logic demands that the government ‘rebalance the playing field’ by adjusting the tax on investment property.

But merely the prospect of that, to say nothing of any eventual policy reality, would send major shudders through the property sector. There would be, there are, an awful lot of injured interests. And so, the immediate emphatic back-off led by Finance Minister Mathias Cormann.

But further, if you did proceed to reduce the tax incentives on investment property, that would then further distort the market, the dynamics and the value of CGT-free owner-occupied housing. It would become the last refuge for the tax fugitive. Apart from, as I have previously discussed, superannuation reserved for truly rich people.

And there’s the nub. You increase the tax on super; you have to move on to investment property. You increase the tax on investment property; you have to move on to the family home. And at that point, on also to the two-seat oblivion of the Canadian Conservatives after their 1993 election.

The saga tells us a number of things about the sad state of policy formulation and political acuity in Canberra. First, in embarking on the ‘good idea at the time’ of increasing the taxation of high-end super, neither political government nor policy bureaucracy seemed to have a clue about the consequences. Yet again we had (inept) policy in the moment.

This set up a clash between policy need and political reality which was never going to be resolved by the government opting to attack negative gearing. The net effect is to lose more political skin — at 46 to 54 two-party preferred, are we now down to bone? — to emerge with even more, policy dysfunction.

All this only one part of the tax system — a system that was, is, crying out for massive deep and wideranging integrated reform. And that was before President Trump. Can anyone in Canberra get real?