Rewarding Effort in Taxing Times

I wanted to write this article in this publication because I truly believe that Australia is at an inflection point. As I outlined just over a year ago in my Tax Green Paper, Australia faces a series of long-term challenges that will determine our future prosperity. Each of these issues is consequential and worthy of substantial policy responses. Take three:

1. Younger Australians are failing to meet the milestones of their parents and are increasingly locked out of opportunities such as homeownership and wealth creation unless they receive significant support from family.
2. Australia – like most developed economies – is experiencing persistently low productivity growth, without which our living standards cannot grow.
3. The global economy, including Australia, is undertaking a difficult but necessary energy transition, which should be done at the lowest possible cost and imposition.

These are by no means our only challenges – we are also grappling with an ageing population, sustained budget deficits, a fractured global economy, splintering social cohesion, the implications of AI on the labour force, and the disruption of the international rule of law. But the challenges of young Australians struggling to get ahead, stagnant productivity and an expensive energy transition are particularly profound and contribute to many of our other problems. And they are united by the fact that they can be addressed – at least partially – by changes to our tax system.

In this article, I focus mainly on the first major challenge – how the personal income tax system can help younger Australian workers by restoring the value of work and improving productivity. In the coming months I will release more work on how changes to other aspects of the tax system can address the other two challenges we face (given these challenges are equally as critical).

Every generation has had their share of hardship. Some Australians fled wars, many have been scarred by economic recessions, and others grew up in a time without many of the comforts of today.

Young people today face challenges of their own, particularly in establishing financial security in the way their parents did. We see this in the stalling levels of household wealth of younger generations, most acutely felt by those finding it difficult to afford housing that is close to family, opportunities and employment.

The tax system is not the only way to solve this intergenerational challenge – for that we need zoning reform, better fiscal discipline, stronger business investment and productivity, and a sustainable economy. But tax should still be a big part of our solution.

There are three reasons why personal income tax should be reformed.

First, our overreliance on labour income has led to an unsustainable and unstable system. As government spending grows, without tax reform our shrinking working-age population will need to pay higher levels of income tax (which is conveniently baked into the system through bracket creep). This has driven successive governments to tinker around the edges, particularly on superannuation, creating uncertainty for people planning their retirement.

Second, high tax rates on labour income cut against our social aims. The tax system taxes wages heavier than other forms of income, encouraging people to seek passive incomes and capital gains over working for a wage. Tax settings also encourage leveraged investment in assets that attract capital gains which, in practice, incentivises investing in property, very little of which represents new supply. It also asks people to pay the bulk of their lifetime tax when they can least afford it – when they’re saving for or paying down a house and raising a family, instead of when they are established and wealthier later in life.

Third, aspects of our tax system are unfair. There is a significant divergence in the amount of tax paid by people on similar incomes, depending on how that income is earned or whether they can structure their affairs using family trusts.

In this article I will propose the following budget-neutral package of reforms, which includes:

1. Reduce the bottom tax rate to 13¹¹1
   This accounts for the Government already reducing the 16-cent rate down to 14 cents by 2027-28.
   cents and cut 2.5 cents off all other tax brackets, saving the average Australian worker earning $100,000 over $1,600 ($137 per month).
2. Taxing earnings from savings and investments at a minimum rate of 27.5 cents, substantially reducing the attractiveness of income splitting within trusts while preserving the current simple and comprehensive income schedule.
3. Lowering the capital gains discount from 50% to 30% to preserve a real rate of return on investments while winding back the strong incentives to invest in property.
4. Ring-fencing deductions from investments so they can only be used to offset earnings on investments, limiting the attractiveness of using losses on investment properties to offset income tax liabilities.
5. Introducing a principled approach to how we tax superannuation that should put the constant tinkering to an end.

This package is not about penalising wealth. On the contrary, it is about ensuring every Australian has the opportunity to build wealth regardless of their circumstances.

Of course, these are not the only options we have to reform our tax system, or even to lower income tax.²²2

I fully expect some people to disagree with my proposals. But the challenge I put down is that the time for talking about tax reform in vague generalities is over. We face dire challenges. Flirting with reform or tinkering around the edges is no longer sufficient - we require bold ambition and big ideas.

Each generation of Australians has faced their unique set of challenges.

Some Australians, particularly from my mum’s generation, will remember their difficult paths emigrating from war-ravaged parts of Europe, Asia or the Middle East. Other Australians will remember the decline of manufacturing, crushing interest rates at 17% in 1990, or the recessions of 1983 and 1991. Others will simply remember growing up on the fringes of our now sprawling cities and regions without many of the luxuries we take for granted today, like affordable, overseas travel.

When I say that younger Australians today are struggling, it is not to diminish the challenges faced by older Australians nor imply that they had it relatively easy.

But as policymakers, our role is to identify what has – throughout all of this – still made Australia the best place to live, work, to raise a family and to start a business, and do our best to protect those attributes for the next generation.

That is, I believe, the essence of our intergenerational compact. And right now, all data points indicate that this compact is breaking down.

Less than 10% of Australians think this generation will, on average, be better off than the last. While it’s true that Australians today can expect a higher standard of living than their grandparents, the traditional measure – GDP per capita – shows Australia’s living standards are stalling and real wages are not experiencing the same rise as previous generations have enjoyed. The Productivity Commission shows that those born in the 1990s are the first cohort whose real incomes will not be materially higher than their parents.

While some luxuries have become more affordable to younger generations than their parents, the barbs about “avocado toast” are simply unfounded. Analysing household expenditure data, the Grattan Institute has identified that this generation spends about $2,000 less on non-essentials than their parents did in the 1980s.

Housing is, of course, where the national conversation around intergenerational equity is most acutely focused. Housing is fundamental to our decisions about when and where to start a family. It plays a key role in our collective cultural identity, and (for better or worse) functions as the main vehicle of wealth creation for most Australians.

In the past 40 years, the share of Australians owning their own home has declined for almost every age category, but with the starkest difference among younger Australians. Home ownership rates for people aged 25-35 have fallen 20 percentage points in that period. Of course, some of this reflects changing preferences – more people study for longer or travel and work in their 20s and 30s before settling down. But we cannot deny the impact that house price growth has had on affordability, and by extension, ownership.

Three of Australia’s major capital cities – Sydney, Melbourne and Adelaide – hold the dubious honour of being in the world’s top ten least affordable cities for housing, as measured by the ratio of sale price to average income. Sydney is second only in the world to Hong Kong.

This has, unsurprisingly, translated into worrying outcomes. The time it takes an average Australian to save for a 20% deposit is now twelve years – up from seven years in 1990 – with some buyers in capital cities taking even longer. This task becomes harder with each passing year; house prices have grown at more than twice the rate of wages. The ‘bank of mum and dad’ has transformed from a safety net to a necessity, with nearly half of all recent first-home purchases across Australia involving parental financial help. To make matters worse, most younger Australians now enter the workforce in their 20s with student debts of roughly $30,000.

As a result, financial security is more difficult to attain. In the 12 years to 2016, the real net assets of an average household over the age of 65 doubled from $530,000 to $1.3 million while the wealth of households under-35s stayed flat. While older generations made significant sacrifices to achieve their financial security, some of the rapid appreciation is a product of good luck, due to a combination of lower interest rates, housing supply constraints, first-home-buyer grants and other demand-side interventions, and generous tax settings. And we should all hope that the two decades of house price inflation at twice the rate of wage inflation we have experienced will not be repeated.

High housing costs are pushing back young Australians’ life milestones. Young people are less likely to start a business, perhaps as a result of declining homeownership. People in previous generations, including my mum, were able to use their homes as collateral to secure their first business loan. Australia’s birth rate is at the lowest point in Australia’s history at 1.5 births per woman – well below replacement rate – and research by e61 Institute shows this isn’t just about personal choice. Financial instability, high childcare costs and challenging career trade-offs are all driving not only fewer births per woman, but also fewer women giving birth at all. 

While a declining birth rate is not unique to Australia, this doesn’t make it any less worrying. With an ageing population, rising healthcare costs are increasingly borne by a diminishing proportion of the population. Australia’s 2023 Intergenerational Report showed that in 1980 we had around six working Australians for each person over 65. Today, we have about four and by 2050 it will be less than three.

The declining share of working-age Australians comes at a time when our spending on transfers is increasingly directed at older Australians. While it’s certainly true that older Australians today are relying less on the aged pension thanks to savings and superannuation, advances in medicine and the provision of in-kind services such as aged care³³3

mean older Australians are drawing more from the transfer system relative to the tax paid. It is, of course, a good thing that older Australians can receive better services and care. But we need to consider how to finance this spending in a more sustainable way.

We need to reform our tax system for three reasons. First, our income tax system is too reliant on a diminishing share of the population at a time when the tax take has the biggest impact on them. Second, the path to prosperity in the ‘land of the fair go’ has been re-written over time, with favourable rates for capital gains over labour income making it difficult to get ahead. And third, Australia is experiencing a proliferation of trust structures that significantly compromise the integrity of Australia’s tax system at the cost of middle-income earners.

Tax reform is too often presented – by the media, commentators and some politicians – as a panacea to all our woes. On housing, for example, estimates from numerous studies consistently show that changes to both CGT and negative gearing would lower house prices no more than a few percentage points. With this in mind, we should recognise that tax isn’t the only tool in the toolbox. But it is a good place to start.  

Australians earn income in a variety of different forms whether from wages, from savings and investments, or from businesses. This is not static, as our sources of income change over our lifetime. Typically, Australians start off earning a wage, putting money away as savings or investments that attract a return, and hopefully retiring to live off the proceeds of their superannuation and other savings.

Australia’s tax base is heavily reliant on taxing income: it makes up about 45% of our total tax take. And it’s rising: the Intergenerational Report estimated – prior to the “stage three” tax cuts – that by 2063, 58% of all tax would be from income. This is nearly 2 in 3 dollars of revenue raised.

Incomes are taxed very differently depending on the source, meaning some people pay much more than others for the same level of income. For example, if you earn $100,000 from wages, you pay around $23,000 in tax. If you earn that in capital gains, you pay around $7,000. If you earn it on your super balance, you pay either $15,000 if you’re still working or nothing at all if you’re retired.

There are reasons for different rates of taxes on incomes, but our system taxes wages more heavily than other forms of income. This means that over someone’s lifetime, they pay the majority of taxes in their peak earning years which also happens to be when they have the most expenses – such as raising children, saving for or paying off a mortgage, while still putting away money for savings. Somewhat counterintuitively, we tax people comparatively lightly when they have built wealth, most likely own their own home outright, have grown-up children, and relatively fewer expenses.

There is a reasonable conversation to be had not about who pays tax, but when. If we taxed sources of income more evenly, Australians might better smooth payment of tax paid over their lifetime to when they have greatest capacity to pay.

Another problem with this system is that it is poorly suited to a country whose principal source of tax revenue – its workers – are a declining share of the overall population. If nothing changes, at least one of four things must occur:

1. Spending – such as benefits, healthcare, education, NDIS – must decline;
2. Working Australians must pay higher rates of income tax to offset the decline in people paying income tax;
3. Taxes from other sources, say the GST or savings, must rise; or
4. Australian Government debt financing of spending must rise.

If we ignore the option to increase debt, the remaining options are all unpopular positions for a political leader to take to an election. Indeed, when they have done so, it has cost them. Both Bill Shorten in 2019 and John Hewson in 1993 lost what were widely considered un-losable elections. John Howard just narrowly avoided joining that list too in 1998 when introducing the GST.

Fortunately for Australia’s political class, they can go a long way without having to have these difficult conversations with the electorate. That’s because Australia’s income tax take rises automatically each year with the rate of inflation – colloquially known as bracket creep. Unlike 17 OECD economies including Canada, the US and the UK, Australia’s income brackets are not indexed to inflation. As a result, Australians find themselves paying higher taxes on the same real income as time goes by. That means, of the four options above, only the second can be implemented without the government needing to lift a pen.

The unspoken compact with the electorate has been that governments incrementally hand back income tax to Australians through one-off reductions every few years. Governments typically do this by “gifting” tax cuts to much fanfare right before an election.

This compact has been honoured at various times over the past 30 years; since the late 1980s, the average personal income tax rate has remained largely steady. Critically, many of these tax cuts have been paid for either by permanent or temporary changes to the tax base. The most notable of these was the introduction of the GST in 1999 (ANTS reforms) and unexpected, highly favourable changes in Australia’s terms of trade in the late 2000s.

Despite modest tax reductions in the last two federal budgets, the Parliamentary Budget Office estimates that in the next 10 years, Australians will be paying the highest average annual rates of personal income tax in Australia’s history. That’s because it would be fiscally reckless to return bracket creep to working Australians, barring any major changes. Australia’s federal budget is in a structural deficit for at least the next decade; the default solution will be that we continue to tax working Australians at higher and higher rates.

Bracket creep is not a credible strategy – as Michael Brennan has noted, if we thought the implied tax rates were optimal, we could legislate them tomorrow. But we don’t. So we had better look to reform instead.

Australian politicians from both sides have long built election platforms on the idea of this being the land of the “fair go”. While we might expect this from left-leaning governments, even conservative governments have tapped this well from time to time, including famously Menzies’ forgotten people, Howard’s battlers and Morrison’s 2019 promise that if “if you have a go, you get a go”. That’s because as Australians we pride ourselves on being an egalitarian society where, irrespective of who your parents are, you will have the opportunity to build a good life for yourself. But as we’ve seen, more Australians are finding it harder to get ahead from hard work alone.

Earning an income from labour should be the great equaliser: any Australian can do it, regardless of status, connections or wealth. But over time, we have fundamentally redefined how prosperity is achieved in Australia. That’s because our system has created incentives that skew towards certain forms of income over others, particularly capital gains.

Contrary to the stylised tax theory, empirical evidence suggests that tax systems don’t so much affect how much people save, but rather where they save it. Capital gains tax (CGT) is paid on none of the capital gains associated with owner-occupied housing, on 50% of other capital gains like those earned through shares, and on 67% of the gains in superannuation funds. By contrast, individuals and superannuation funds pay tax on 100% of investment earnings from other cash flows like bank interest and dividends.

There are many arguments as to why capital gains should be treated differently to other investment income – including accounting for inflation, smoothing of lumpy income – but the problem is that we don’t extend these principles to other forms of investment income. The scale of the current CGT discount strongly incentivises earning income as a capital gain. In conjunction with negative gearing rules, it encourages Australians to make investments that generate capital gains rather than recurrent income, and encourages leverage, which in practice drives investment into leveraged property.

At least partly as a result, Australia has developed an obsession with property investing that isn’t seen to the same extent in other parts of the developed world. Australia has the second highest rates of household wealth associated with secondary housing (investment properties) in the OECD, lower only than Luxembourg.

Not only has this impacted Australia’s property market, but it has also had profound implications for Australia’s economy. Australia’s banking sector – which dominates the ASX with the “big four” banks accounting for nearly 20% of our stock market – has had the business model rewritten away from lending to productive businesses and increasingly towards mortgage lending for predominantly existing homes. Collectively, Australia has 12 trillion dollars locked up in residential property – a relatively unproductive asset class that doesn’t substantially increase the future productive capacity of our economy. 

This has also shifted the ways to build wealth in Australia. Instead of investing in your own human capital through education, the path to prosperity is to, as quickly as possible, acquire an asset that will accrue capital gains. After all, the very worst thing you can be in Australia – at least from a tax perspective – is a wage earner.

That’s a particularly tough problem for young Australians looking to get ahead. Young Australians are more likely to earn their income through wages, rather than capital gains. Many young Australians have simply not been able to save up the wealth to access leveraged investment. And their greater tax burden is felt at a time when they are least able to pay it. For our intergenerational compact to hold, this must change. 

Australia’s income tax system is generally horizontally equitable. That is, 95% of our population – who account for 63% of income tax revenue – pay similar levels of tax for similar levels of income. But for the top 5% of income earners – who account for the other 37% of taxable income – there is a wide disparity in the rates of tax paid by as much as 20 percentage points. This is principally a result of Australia’s treatment of capital gains which accounts for 80% of the difference.

But the proliferation of family trusts also plays a major role in the growing unfairness in the tax system.

Family trusts are not a new feature of the tax system, although their popularity has grown substantially over the years. Australians use family trusts for many valid reasons, like protecting family assets through bankruptcy or family separation, or to plan for future ownership of a family business. But the number of trust structures is growing in Australia at a much faster rate than actual businesses.

This growth is unsurprising given the tax benefits and not just for those on high incomes. For those who can – mainly self-employed Australians or sole traders – family trust arrangements allow income to be split between family members, enabling them to reduce each member's marginal income thresholds and lower the total tax paid by the family unit.

For example, consider a middle-income couple earning $100,000 where one partner is not working. Outside of a trust, this household would pay $20,800 in tax. By creating a trust and splitting the income between the working and the non-working partner, essentially meaning each partner is “paid” $50,000, the family tax bill is just $11,600 – a saving of $9,200. 

And that’s just a relatively simple example. The ANU’s Tax and Transfer Policy Institute (TTPI) published in 2022 the Australian Tax Planning Playbook (somewhat cheekily named) demonstrating just how easy it is to create complicated structures that allow people to receive privileged tax treatment.

The limited availability of data on family trusts makes it difficult to estimate how much income splitting is costing the budget. But there is some evidence suggesting its impact is substantial: the PBO has found higher-than-normal degree of trust income bunching around thresholds, indicating households optimising their taxes. Similarly, the spread of trust income across age cohorts is largely consistent with non-trust income, except for an anomalous spike in the distribution of trust income for 18–24-year-olds (who typically sit in lower marginal tax rates).

Ultimately, there were over 1.8 million individuals reporting to receive $71 billion in trust income in 2022-23, representing 10% of all taxable income from individuals.

To meaningfully support the next generation, we should substantially lower taxes on income from labour. This is the best and fairest way to encourage Australians, regardless of their circumstances, to invest in themselves, get educated, find good jobs or start good businesses. Each of these outcomes are critical to delivering the next wave of prosperity for all Australians.

But good reform is expensive, and with the consolidated fiscal position – both states and federal – in sustained deficits, it is neither practical nor responsible to make significant unfunded tax cuts. This forces us to consider shifting the tax base elsewhere in the economy.

The best examples of substantial tax reforms in Australia occurred in 1985 and 1999. In 1985, the Hawke-Keating Government introduced the “Reform of Australia’s Tax System” packages (known colloquially as RATS) which among other things introduced capital gains tax. A New Tax System reforms (ANTS) in 1999 introduced the GST alongside substantial cuts to income taxes. The impacts of both ANTS and RATS on average tax rates are visible above.

Some point to other tax bases, typically company tax, resource taxes, or the GST to fund lower individual income taxes. These are important taxes, but not ones I have considered in this instance. Rent taxes should be better applied to Australia’s natural resources but they are inherently volatile because of price fluctuations such that they are not well suited to ongoing reductions, rather better suited to budget repair. Company tax interplays with other significant economic challenges relating to declining investment and sluggish productivity and will be considered in future white papers. The GST could be either broadened or increased however I don’t think the public would accept this proposal at a time of high inflation. In addition, the need to compensate low-income Australians and negotiate additional payments to the states would mean there isn’t as much left over for tax cuts.  

I therefore propose we fund significant tax cuts by rebalancing how income is taxed across income sources in a budget-neutral way; any taxes raised are handed back to Australians through lowering the marginal tax rates. This helps address intergenerational challenges by lowering rates but also by removing distortions created by the way we currently tax savings.

I propose that Australia substantially reduces labour income taxes by rebalancing the income tax cuts towards other sources of income while still preserving the incentives to save and invest. This package has been based on costings prepared by the PBO to be budget-neutral. It has five components.

1. Lower the bottom tax rate to 13 cents⁴⁴4
   The Government has already legislated the bottom rate to fall from 16 to 14 cents by 2027-28.
   and take 2.5 cents off all other income tax brackets
2. Implement a minimum tax rate on capital earnings
3. Reduce CGT discount from 50% to 30%
4. Limit deductions on investment losses to investment income
5. Take a principles-based approach to taxing superannuation

The remainder of this section outlines the rationale for each.

The best way to help younger Australians get ahead is by restoring the value of work and letting them keep more of what they earn. Therefore, we need to start by reducing income taxes across the board. I propose dropping the lowest marginal rate to 13 cents and reducing all other rates by 2.5 cents. This would cut the tax bill by $1,643 for someone earning $100,000 a year.⁵⁵5

Lower taxes on labour income allow each generation to have the opportunity to build their own prosperity regardless of their parents' background or contribution. Younger people with relatively few assets can only build wealth by working and saving. Reduced tax rates on labour income would also increase the incentives for second income earners to work. In practice, this would encourage more women to work more, which has a positive impact on economic growth.

The cuts in the tax rate across all tax levels are intended to broadly retain the current level of progressiveness and to ensure that aspiration and effort are rewarded. Because those on higher incomes pay a larger proportion of their income in tax, the percentage increase in take-home pay for higher income earners would be a little higher (2.9% for $170,000; 2.1% for $75,000).

Alternatives to this proposal include either full or partial indexation of the tax thresholds. As discussed above, there is very strong justification for this as it would reduce the increase in taxes by stealth. However, this needs to be paired with and funded by more restrained government spending to ultimately be sustainable long term. It also makes changing the thresholds less likely in the future and there is every indication that Australia’s current tax thresholds are not optimal. For example, Australia’s top marginal rate is not particularly high at 45 cents (excluding the Medicare levy) but it kicks in at a relatively low range at just 1.7 times the median income. I support indexing, but think we need to reset the levels first, as in this proposal.

I propose that the minimum tax rate for earnings on investment income should be 27.5 cents in the dollar. With our current income structure, it has been too easy for beneficiaries of trusts who are income splitting to pay too little tax. Putting a floor on their tax rate would go some way to fixing this problem.

Under this proposal, Australia would maintain its current progressive income schedule, yet income earned from investments would attract – at a minimum – a rate of tax at 27.5 cents, subject to the 30% CGT discount. The mechanics of this are relatively simple using a “working income tax credit” - a solution used by a number of countries, including the United States and the United Kingdom, to provide specialised tax treatment for income derived exclusively from labour.

At first glance, a minimum tax rate on investment may seem unusual. But it is a well-established concept in tax policy. Often proposed as part of a dual income tax system, where labour and capital income are taxed separately, minimum tax rates have long had support in Australia. The ANU’s Tax and Transfer Policy Institute has advocated a flat rate on capital income since its 2020 work on savings taxation, and options “representing a form of dual income tax” were considered in the 2009 tax review led by former Treasury Secretary Dr Ken Henry. The benefit of the system I propose is that it maintains the progressivity and simplicity of a comprehensive income tax schedule, while also taxing earnings from capital more consistently.

While the minimum rate of tax means that capital income would no longer be eligible for the lowest marginal rate and the tax-free threshold, this would be partly offset by my proposed reduction in tax rates by 2.5 to 3 cents on the dollar across the board. The changes would have no impact on those with wage income more than $45,000 per year (who would benefit substantially from the 2.5 cent tax cut).

The key benefits of this proposal, however, are its impact on reducing the incentives to split income. By creating a minimum rate of tax on investment income, the attractiveness of redirecting capital income to a family member has declined from as much as 45 cents in the dollar (difference between the top and bottom marginal rates) to just 15 cents in the dollar (the difference between the new top rate 42.5 cents and the minimum rate of 27.5 cents). Trusts could still direct ‘wages’ to people, but this would then be far easier for the ATO to verify. While it doesn’t eradicate the incentive entirely, it significantly reduces the appeal.

Third, I propose we reduce the capital gains discount from 50% to 30% so that tax is collected on 70% of the gain instead of 50%. To be clear, there are valid reasons for having a discount on capital gains, including the impact of inflation on an asset’s nominal value. The problem is that we don’t extend these considerations to other forms of investment income, providing a disproportionate incentive to earn income as capital gains rather than interest or dividends.

As noted, the CGT discount was introduced to promote productive investment. But, in practice, it strongly incentivised leveraged investment which has in part fuelled Australia’s obsession with property investment. Reducing the discount will reduce this distortion.

There are valid concerns about how changes to the discount will impact other investment incentives. These impacts are unlikely to be significant, since I am proposing no changes to the specific CGT rules relating to small business that apply in addition to the CGT discount.

Similarly, when the discount was introduced in 1999, there was no discernible increase in investment, so a partial unwinding of the discount is unlikely to substantially decrease investment. If anything, it may remove artificial incentives to invest in housing towards other more productive investments.

Concerns that reducing the CGT discount will impact housing supply come from two directions:  first, that reduced demand for property investment will reduce the supply of new housing. And second, that reduced investment demand from investors will lower rental availability in the market and drive-up rents. These concerns are both overstated.

On the first point, the CGT discount impacts a very small minority of new housing construction. Since corporations are not eligible for the CGT discount, the only new housing impacted by the discount are developments owned by individuals and owner-builders who live in the home once it’s completed. Only 13% of new investor loans are for the construction of new homes and given there are about 175,000 new developments started each year, individual investments in new construction at any point in time likely represent a very small share of the total 2.4 million rental properties held privately in Australia.

Given that new developments occupy such a small share of investor demand, this implies that the majority of investors compete with owner-occupiers for the existing supply of housing. To the second point then, we can expect that – particularly during a housing shortage – any reduction in demand from investors would be offset by an increase in owner-occupiers, a case economist Saul Eslake makes well. Therefore, if there is any decline in the supply of rentals, there will be a near equal reduction in the demand for rentals.

Estimates from economists at NSW Treasury suggest that reforms to CGT and negative gearing could increase the share of owner-occupied housing by 5%. Ultimately, any impact on housing would be incredibly small. Economist Chris Richardson recently calculated that a reduction in CGT discount to 33% would have a roughly equivalent impact to house prices as the most recent interest rate rise.

I propose to limit deductions incurred in earning non-labour income, such as interest on rental properties (i.e. “negative gearing”) so that they can only be deducted from non-labour income or carried forward and used to offset on the disposal of the asset. Australia’s treatment of investment losses is seen as more generous than comparable economies where limiting deductions is now standard practice.  

As with reducing the discount on CGT, there are concerns that this would have consequences on the availability of rentals and the development of new housing. These concerns should be treated seriously, but with equal scepticism. The objective of these changes is to reduce artificial incentives in the tax system that steer investors towards leveraged investment in property over other, potentially more productive, uses of capital. It would also help to even the scales back in favour of home ownership.

Australian research on the impact of both reducing CGT and limiting negative gearing has consistently found a small but negative impact of between 1-4% on house prices relative to the counterfactual.

Australia’s superannuation system is world-class. It is a critical asset of the Australian people, provides a valuable pool of patient investment capital and has helped Australia manage the effects of an ageing population much more effectively than other countries. 

Given superannuation is forced saving and inaccessible in most circumstances until you are 60, it has strong grounds for deserving tax concessions. But these concessions are substantial, costing $55 billion per year, and are one of the primary reasons that a shrinking proportion of older households are paying tax while they consume a growing share of the budget.

The scale of contributions has meant that governments have been constantly tempted to tinker with the system – such as introducing contribution limits, transfer balance caps and now introducing higher rates of tax on large balances. These have all brought the system closer to its legislated purpose – to provide for a dignified retirement – but the effect is that this undermines confidence and stability in the system.

The best way to stabilise superannuation tax concessions would be to explicitly link them in a principled way to the income tax system, and to curtail them when they would provide more income than is needed for the legislated purpose of a ‘dignified retirement’. That’s why I propose a version of the current concessions that approximately align with current tax scales on labour but at a constant discount up to the top marginal rate. I appreciate that means further changes. These are non-trivial and need to be done carefully over a period of say, 10 years. But the hope is that these changes can finally bring stability to the system for the long term.  

The difference between the Government’s proposal and the one I put forward is that my proposal more closely resembles the way we tax income outside of super but a constant discount up until the top marginal rate. At this point, there is limited policy rationale for providing further concessions for a person earning more than $200,000 per year – more than 94% of Australian taxpayers.

While tax rates are increasing, this is still as a substantial discount compared to the same earnings outside of super. Take a super balance of $2.5 million currently in the retirement phase. At 6% return (historically returns have been around 7%) this balance will earn around $150,000 per year. Under my proposal, it will pay around $13,500 in tax at an average rate of 9%. Outside of super this same income would incur $36,409 in tax.

Any changes to superannuation need to be approached with particular care, particularly for those on lower incomes with less room to move. Newly imposed taxes on someone already retired or close to retirement have a material impact. I would welcome a system that allowed these proposals to come into effect over a period of ten years, to allow the system to coordinate and to enable ample time for Australians to plan for their future, confident that with these changes the system is stable and sustainable for the future.

On balance, the tax system we have built does a reasonable job of adhering to core tax principles of equity, efficiency, simplicity and sustainability. But while tax systems should be stable, they cannot afford to be static.

Tax systems need to adapt from time to time to address the underlying changes in our society, our demographics and our general tax base. Now is one of those times. Australia’s young people are finding it harder to achieve the financial security necessary to start families, to start businesses, and to feel hopeful that they can have a good life. All the while, our tax system is increasingly reliant on them.

Tax systems can and do change. We saw that in 1985 and again in 1999. These reforms strengthened our tax system; their principal beneficiaries are now retired or approaching retirement age. With this in mind, generational change is needed now to ensure that our tax system continues to enable younger, working Australians to earn, to save, to build wealth. It’s right to be cautious but we cannot afford not to act.

While the productivity challenge must ultimately be solved by the private sector, government has a role to play in getting the settings right for business. Some good suggestions have been canvassed in other Inflection Points articles, and I will have more to say this year about how the corporate tax settings can support a growing, more dynamic and internationally competitive economy.

This proposal is one that I want to contribute to that debate. I invite people to consider, to test, to challenge, and to put forward alternative solutions to the problems we face. For the full details, I refer people to my White Paper on my website.

Lowering taxes on working Australians won’t fix all our problems. Australia faces considerable challenges, particularly in growing our economic pie. Australia’s productivity has been in the doldrums for more than a decade, businesses are not investing, and real wages are stalled as a result. Reviving these indicators is important to ensuring that young Australians continue to have opportunities in this country.

However, the time for vague generalities about the need for tax reform is over – we no longer have the luxury. We need boldness and we need ideas so that the issues can be debated on merit, considered carefully by our leaders, and explained to the public with honesty.

I believe there is strong momentum building for tax reform, not just from policy experts and academics but from everyday Australians too. There is broad acknowledgement that the system is broken, and a willingness to consider change if the reasons and ideas are presented clearly and thoughtfully. Let’s not waste it.

Correction: This article has been amended to clarify the proposed timing of these changes and the scope of the Parliamentary Budget Office's costings.