Australia’s capital gains tax (CGT) policy has been largely settled for almost 20 years. However, it has come under renewed scrutiny as a result of the Australian Labor Party’s federal election platform proposal to halve the 50% CGT discount and thereby effectively increase the tax by 50%.

If the objective of reforming the CGT is to do no more than compensate for inflation, no flat percentage discount will achieve it other than by chance; and a 25% discount will not be sufficient to achieve it in many cases. Even the 50% discount fails to achieve it if the rate of nominal capital gain on an asset is less than twice the rate of inflation.

Inflation compensation would be better achieved by returning to the cost base indexation system that applied up to 1999.

However, there are many justifications for a CGT discount other than compensating for inflation, and those reasons — such as the effect on incentives to invest — are being overlooked in the current debate. A flat percentage discount is a simple design and should be thought of as a rough and approximate way to recognise all the reasons for a concessional CGT.

Rather than halve the discount, it would be better to either:

• Retain the 50% discount, OR
• Restore cost base indexation and apply a small discount (say 10 – 20%) to real gains.