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CAPITAL GAINS TAX:ANALYSIS OF REFORM OPTIONSFOR AUSTRALIAAlan Reynolds
Senior Fellow and Director of Economic Research, Hudson Institute(Washington D.C., United States)A study commissioned by the Australian Stock Exchange Ltdfor the Review of Business TaxationJuly 1999
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Table of Contents
PageExecutive Summary 3I. Theoretical Issues: What Are Capital Gains? 7II. CGT in Australia: Legislative Provisions and Tax Revenue14III. Overseas Experience With CGT23IV. Estimating Realizations and Revenue at Lower Tax Rates29V. Assessment of Alternative Means of Reform45VI.Benefits of Reform: Entrepreneurship and Competitiveness55VII. Potential Drawbacks of Reform: Tax Avoidance Issues71VIII.Potential Drawbacks of Reform: Distributional Issues83Endnotes91
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Executive Summary
Australia - Out of Step on Taxing of Capital Gains
Two U.S. economists of the 1920s and 1930s, Haig and Simons, still influence tax policy inEnglish-speaking countries - three of which (the U.S., U.K. and Australia) have experimentedwith taxing capital gains at income tax rates, but only one (Australia) still continues to do that.Critics of the Haig-Simons “comprehensive income tax base” sometimes argue that the capitalgains tax on income-producing assets should be zero, or at least relatively low, because theincome will be taxed later, when it is earned. Proponents of Haig-Simons, by contrast, claim tosee no difference at all between capital gains and a monthly salary or dividend check.Australia’s vision of “tax reform” has long been to shift away from excess reliance on a traditional“income” tax base toward greater reliance on a consumption tax base. But a high tax on capitalgains moves in the opposite direction, and can only be rationalized on an archaic but currentlycontroversial Haig-Simons definition of income.In 1985, Australia went from having no comprehensive tax on capital gains to having by far thehighest maximum CGT for individuals of any major economy. Many countries do not bothertaxing individual capital gains, such as Germany, the Netherlands, Belgium, Hong Kong, andSingapore. Others, including Taiwan and South Korea, exclude corporate shares. Most othercountries tax gains at rates no higher than 20%, although require a minimum asset holding period.
Lower Tax Rates Will Unlock Unrealised Gains
Nobody has to pay the capital gains tax, except in situations of financial distress. Taxpayers cansimply avoid buying any more assets that are subject to this tax, and defer selling any assets theyalready own. The CGT is largely a voluntary tax, and Australia is short of volunteers.Over the years -- as fewer and fewer pre-1985 assets remained in hands of their original, tax-exempt owners -- the revenue yield from Australia’s CGT might have been expected to becomesignificantly larger. Yet there has been no clear upward trend in CGT receipts from individuals(relative to GDP), which have largely moved up and down with the stock market.The bulk of capital gains tax revenue comes from superannuation funds taxed at 15% andcompanies taxed at 36%. In 1996-97, individuals who realized gains and also had ordinaryearnings of more than $50,000 accounted for 28.4% of
individual
capital gains realizations, or$823 million. The 47% tax rate thus accounted for only $387 million of the $2.1 billion of capitalgains tax receipts from all sources. The 43% tax rate accounted for another $101 million of CGTrevenue, and the 34% rate for $171 million. So, the top three tax rates combined brought in only$659 million, or 31% of total CGT receipts. If tax rates did not affect the amount of gainsrealized and taxed (which is emphatically untrue), then
reducing the top three tax rates to a flat rate of 30% would have reduced static revenues by only $191 million
. With even the slightest
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