The case against levying CGT on the family home

No tax reform debate would be complete without the appearance of hoary old chestnuts like a capital gains tax (CGT) on principal residences (aka ‘the family home’). Such a proposal has been launched today from a predictable source, The Australia Institute, and given sustenance by an unlikely source, the Australian Financial Review.

Wanting to appear reasonable, Treasurer Scott Morrison will probably repeat the mantra that ‘everything is on the table’, but the reality is that the idea of applying CGT to the family home has about as much future as an ice block on Bondi beach on a hot day. It will not be part of the government’s tax reform package, and nor should it be.

Taxing the family home is the third rail of Australian politics. It would mean instant death to any political party that touches it. It is a particularly hot issue in Sydney, Melbourne and their surrounds, with some sixty federal electorates between them. Malcolm Fraser knew that way back in 1980 when he ran a successful scare campaign on this issue against the Hayden-led opposition, and Bob Hawke knew it when his government introduced the CGT in 1985 with a carve-out for principal residences.

A parliamentary committee inquiring into the tax expenditure statement also recognised the realities when it recommended, just before Christmas, that the claimed $46 billion of tax expenditure attributed to the CGT exemption for principal residences should not even be included in the statement.

So much for the politics of it – what about the economics? The Australia Institute accurately repeats the $46 billion figure from the tax expenditure statement, but it is important to understand that this total has two components – one from principal residences being exempt from CGT on half the capital gain (a tax that does apply to other assets), and the other from the 50% concession that applies to all assets.

The Australia Institute proposes that the exemption be remove for principal residences worth more than $2 million and claims that the revenue gain would be about $3 billion a year. However this assumes abolition of both components of the exemption. In other words, their proposal is part of a broader agenda to tax capital gains at full rates on all assets, with no discount. If the change was only to subject homes worth more than $2 million to the same CGT as currently applies to other assets (that is, with a 50% discount), the claimed revenue gain would be much less.

Another reason to doubt the claimed revenue gain is that it makes no allowance for behavioural responses by the owners of the assets in question. The reality is that the CGT acts like a turnover tax, and if it applied to principal residences there would be substantially less turnover. CGT has the effect of locking people in to the assets they own. That combined with the strong likelihood of existing residences being grandfathered, and the fact that if CGT were applied then interest expense on family homes would become a tax deduction, means the revenue gain would be a fraction of what is claimed.

There is very respectable economic case for having no CGT at all on any assets. CGT amounts to double taxation on savings and is a significant impediment to investment. But at the very least, the current 50% discount should not be reduced.

Is there a case for paring back the exemption for principal residences and bringing it into line with other assets, with a 50% discount? Like the Henry review five years ago, I think not. As Henry explained, the current tax treatment of principal residences equates to an expenditure tax, which is appropriate for the main form of household saving. The fact that higher income households are the largest beneficiaries is neither here nor there. The correct tax treatment should be applied without discrimination.

A final consideration is that unlike other assets most family home sales take place not to generate income but to fund the purchase of another home of equal or greater value. Any tax on the capital gain would reduce the owner’s wherewithal to maintain the same standard of housing. This is recognised in the US, for example, where CGT applies to principal residences above a threshold, but subject to a rollover provision which enables the taxpayer to defer CGT as long as the proceeds of a sale go into another home.

In the unlikely event that CGT is ever imposed on family homes in Australia, a similar rollover provision could be expected, which is another reason to believe the revenue gain would be slight. The few people left paying CGT would be the elderly whose homes have increased massively in value over many years and who may want to trade down. Do they really need the additional discouragement of a CGT?

Robert Carling is a Senior Research Fellow at the Centre for Independent Studies, author of Right or Rort? Dissecting Australia’s Tax Concessions, and co-author of Exposing the Stealth Tax: the Bracket Creep rip-off.