Labor’s high-risk tax revolution

If the Labor Party wins the next election — which it definitely would if it wasn’t for the
contents of this column, which make a Labor victory less certain — Bill Shorten and
Chris Bowen will bring about one of the biggest tax reforms this country has even seen,
possibly the biggest.

They will do five things (and counting, maybe more by the time we get there) roughly all
at once:

● Restrict negative gearing to new dwellings;
● Halve the capital gains tax discount from 50 per cent to 25 per cent;
● Remove dividend franking cash refunds;
● Tax all discretionary trust distributions at 30 per cent; and
● Repeal the company tax cut for businesses with revenue of up to $50 million.

Each of these things has been announced and is well known, and each is defensible in the
context of chronic deficits and big calls on the budget for health, welfare and
infrastructure, but taken together they would be little short of a revolution, matched only
by the Coalition’s Fightback! plan in 1993, which never happened, because it lost the
unlosable election. (Bill Shorten take note.)

The worst thing, and most dangerous electorally, about the coming tax revolution is that
in many cases it will hurt low-to-middle-income earners, the people whom Labor
purports to represent and champion, rather than, or as well as, the financial elites it
claims to be going after.

There will also be an emissions trading scheme to support Labor’s 45 per cent emissions
reduction target and probably some kind of reverse auction wholesale price guarantee for
renewable electricity generation to support its 50 per cent renewables target. Not that
those things would be taxes, or bad, but the government will no doubt call them a carbon
tax, which will add to the atmosphere of dramatic taxation change next year.

These are just the nasties we know about before the election campaign starts. Presumably
the money will be spent on nicer things during the campaign.

Restricting negative gearing to new dwellings and halving the capital gains tax discount
are meant to be an attack on rich property investors, as well as, in the case of the negative
gearing change, an attempt to encourage more housing supply.

I have some sympathy with cutting the capital gains tax discount. It was originally
designed to replace the indexation of capital gains for tax purposes, which was there to
remove the taxation of normal inflation and tax only capital gains in excess of the CPI.
Indexation was too complicated so the Howard government introduced the discount in
1999 for assets held longer than 12 months. In those days the inflation rate was 5 per
cent, so given the average time that assets were held, and the average marginal tax rate, a
50 per cent discount was about right. No one would have thought then that, less than two
decades later, inflation would be stuck at below 2 per cent, but it means the discount is
about twice what is needed to offset inflation. So the cut in the discount is theoretically
justified.

The problem is that, with the disallowing of negative gearing tax deductions for existing
properties, the two tax changes could have a dramatic impact on an already soft property
market. The market may not crash, at least not any more than it would have anyway, but the
negative impact on the resale value of houses and flats will ensure that the property
downturn lasts much longer than it would have.

And it probably won’t do much for housing supply either. Investors will be all too aware
that new dwellings become existing ones as soon as they have been bought from the
developer. They will take into account the reduction in resale value and therefore capital
gain that they face in future — of which, by the way, three-quarters will be taxed at the
marginal rate instead of half.

The removal of cash refunds of dividend franking will, by definition, mostly affect low
taxpayers, especially retirees. It is discriminatory and arbitrary, and will cause a loss of
income for those who can least afford it.

This proposal, and the plan to tax all discretionary trust distributions at a flat rate of 30
per cent, are the things most likely to cost Labor the election, if anything could with the
Coalition being virtually unelectable, as things stand.

Users of trusts to distribute pre-tax income include small family businesses, where the
spouse and children actually do work in the business — doing the books for contractors,
and working behind the counter in shops. Labor’s policy stops those beneficiaries from
accessing the tax-free threshold which, as with retirees relying on franking credit
refunds, will cause a big drop in after-tax income.

If that quite large army of people can bring themselves to vote for the Coalition, they
will.

Repealing the company tax cut for businesses earning revenue of up to $50m probably
won’t happen next year, but it will add to the sense that Labor is going after the small end
of town. And with the OECD average tax rate now at 23 per cent, the pressure to reduce
company tax will not go way.

I wrote the other day that the election could be the first truthful referendum on climate
change, ever, which would be good, but there’s a good chance that energy could be
overshadowed by tax.

This article was produced by Alan Kohler who is the publisher of The Constant Investor.