This blog post is based on Asprey and the Taxation of Wealth: Where to Next? by Chris Evans, Rick Krever, and Peter Mellor.
In the face of growing wealth inequality between and within nations, attention in almost all developed economies has turned to the possible use of wealth or wealth transfer taxation to ameliorate the divide. Fifty years after Australia started to dismantle its robust gift and estate tax regime, and 73 years after the Commonwealth ended its principal wealth tax system, many are wondering whether it is time to reconsider the need for wealth or wealth transfer taxes in this country.
A Forgotten History of Wealth Taxation
Ironically, Australia was once a leader in wealth and wealth transfer taxes. Prior to Federation, all Australian states imposed wealth transfer taxes as well as full or partial income taxes, and most had imposed land taxes—imposts that remained in place after 1901. And less than a decade after Federation, the new Commonwealth government adopted a wealth tax based on landholdings intended to break up large landed estates. This was followed a few years later by a Commonwealth estates tax intended, in part, to reduce large parcels of wealth transferred at death, and later matched by a gift tax aimed at transfers of wealth prior to death.
The Federal Land Tax lasted just over 40 years. The wealth transfer taxes lasted just a little longer. Beginning in 1976 with Queensland, the states and federal governments abolished their taxes on wealth transfers at death and by gift prior to death. This left transfers of wealth entirely outside the tax system, apart from a very limited number of stamp duties imposed on some transfers of property and some state land taxes.
At the same time, a very weak income tax actively encouraged a skewed acquisition of wealth. It imposed high tax rates on labour income of the aspiring classes while entirely exempting the main form of income derived by the very rich: gains realised on the sale of investments.
The Capital Gains Concession and the Power of Deferral
The bias of the income tax system in favour of wealth accumulation by the country’s wealthiest was mitigated slightly in 1973, when gains from short-term investments were added to the income tax base. However, it was not until 1986 (with effect from September 1985) that gains from long-term investments were made subject to income tax.
The measure was applied for 15 years until its impact was dramatically reduced from September 1999 under changes to the income tax introduced by the Howard government. John Howard had strongly opposed the inclusion of investment gains in the income tax initially, and his 1999 changes introduced an exemption from income tax for half of investment gains realised on assets held for at least 12 months.
The concessional half-exemption of investment gains from income taxation was compounded by a further concession that allowed investors to defer paying tax on their gains by simply electing where their wealth should be invested. Ordinary businesses and workers pay tax annually on their gains. Investors may also enjoy annual gains on the value of their investments, but each year make an evaluation—known as portfolio choice—deciding whether the assets they own are likely to rise in value at the same rate or a greater rate than alternative investments, and consequently whether they should retain their wealth in existing investments.
If they decide to change investments, they are said to have “realised” their gains, and the non-exempt half of those gains is subject to income tax. However, if they make the choice to keep their wealth invested in the same assets for another year, recognition of the gains accrued during the year is deferred until the assets are sold.
The Political Hurdle of “Death Taxes”
The prospects for tax reform based on the taxation of wealth or wealth transfers are dismal at best. Apologists for the wealthy have run a remarkably effective campaign equating wealth transfer taxation with unjust appropriation by the government of private property. They have created the widely accepted illusion that wealth taxes—and in particular, death taxes—will hit working- and middle-class families hard.
Labelling a tax, including any aspect of the income tax, as a “death tax” is a strategy almost certain to guarantee its demise. The reality may be far different: modern wealth and wealth transfer taxes are usually designed to apply only to the ultra-rich and can easily utilize tapering thresholds to keep all but the very rich out of the system. Still, perceptions matter, and energy spent on reviving wealth or wealth transfer taxes is unlikely to yield tangible results.
A Blueprint for Reform: Lessons from Superannuation
There may be a more viable path to reforming the income tax on wealth accumulation, however, as illustrated by the government’s recent reform of superannuation taxation.
From the outset of federal income taxation in Australia in 1915, income put aside for retirement savings has been concessionally taxed. The concession was adopted to encourage workers to save for retirement when it was feared young workers, in particular, might be too myopic to realise they need to put some income aside for their retirement years. This rationale disappeared once Australia adopted a compulsory retirement savings system, but the concession—a lower tax rate on income contributed to a superannuation fund and on gains realised on a fund’s investments—remained in place.
Unsurprisingly, the concessional tax regime for retirement savings was fully exploited by very wealthy taxpayers who held significant parts of their investment portfolios in their superannuation funds, where gains were taxed at reduced rates. When the exploitation of this tax concession rose to unsustainable levels, the government finally moved to reduce it. They first attempted to do this by increasing the concessional rate on excessive savings in superannuation funds, and secondly by removing the portfolio choice option. Consequently, had the reforms been adopted as originally presented, gains would be taxed on an annual basis, regardless of whether investments remained in the same assets at the end of the year or had been realised and shifted to other investment assets. The Government found a number of compromises were needed to secure support for its proposals in Parliament, including a retreat from the annual recognition of gains whether assets had been sold or retained. The law, as originally drafted, however, provides model legislation for a system that taxes gains as they arise, removing the option to defer tax until a later time when assets are sold.
Extending the Logic to Broad Investment Gains
While investments in their superannuation funds are an important part of the total investment portfolio of the very wealthy, they constitute an ever-diminishing share of total investments as income rises. A broader reform of the taxation of investment gains is needed if Australia wishes to address the nation’s growing inequality.
The proposals for reform of the superannuation taxation regime and changes to the proposals as the reform measures progressed through Parliament provided two important lessons for those seeking reform of wealth taxation. From a law design perspective, the initial proposals showed that it is technically not difficult to tax investment gains as they accrue, regardless of a taxpayer’s portfolio choice to sell or retain appreciated investments. Second, the superannuation reform that was enacted, higher tax rates for gains realised by wealthier taxpayers on very large balances in concessionally taxed funds, illustrated how the political case for reform can be made if it is presented in a convincing fashion.
A starting point might be for the government to show how the benefit of the deferral of tax now enjoyed by investors accrues primarily to the small percentage of Australians in the wealthiest slices of society.
