Don’t eat the seed corn, Jim

If Jim Chalmers increases the tax burden on capital gains, it would mark the biggest backflip on a tax pledge since Paul Keating's infamous 'L.A.W. law' income tax cuts.

Keating, desperate to win the 1993 election, legislated tax cuts before polling day – only to repeal them almost immediately after victory. Voters didn't forget. At the 1996 election, they punished him with a landslide loss to John Howard.

Yet this is precisely the kind of betrayal being hinted at now. Journalists are reporting that Labor is considering hiking capital gains tax as part of its upcoming productivity summit. Would 'Gentleman Jim' really be such a bushranger? Perhaps.

For many politicians, breaking promises is as natural as breathing.

But if he and the Prime Minister are looking to history, they should look carefully.

Keating's U-turn did long-term damage to Labor's credibility on economic management. Going after capital gains now might do the same.

Even more concerning is that it's bad policy.

There's a reason capital gains are taxed more lightly than income – or not taxed at all in some countries.

Capital is the seed corn of future prosperity. It funds the investment that leads to higher productivity, which in turn leads to higher real wages and national income. Tax it too heavily, and you discourage people from planting at all.

Investors take risks. When they succeed, they create future income streams – for themselves and for the government, which taxes that income. Penalising success at the point of capital realisation is shortsighted: it delays investment, reduces mobility, and encourages wealth to flow elsewhere.

And there are plenty of 'elsewheres'. Countries like Singapore, Switzerland, and Hong Kong don't tax capital gains at all. Unsurprisingly, they attract capital – and they're wealthier per capita than Australia. That's no coincidence.

There's a deeper theoretical flaw. Taxing capital gains is a form of double taxation.

An asset's value is simply the sum of its expected future income, discounted to the present. But that future income is already taxed. When an asset increases in value – because income has risen or interest rates have fallen – taxing the gain amounts to taxing the same income stream twice.

Worse, not all gains are real. Inflation can push up asset prices without creating any real wealth. In such cases, capital gains tax erodes purchasing power and leaves investors worse off in real terms. That's why Paul Keating, when he introduced CGT in 1985, at least had the good sense to index gains to inflation.

We don't index anymore. That aspect is taken care of via the 'discount' which levies tax at the taxpayer's marginal rate on half the profit only. It's a rough and ready way of adjusting which also takes into account the special nature of capital gains taxation.

And when gains reflect falling discount rates, something which generally occurs when interest rates drop, the next owner may well face a capital loss if rates rise again. The 'gain' is just a timing illusion, and taxing it creates further inequity across time and ownership.

Capital gains tax also distorts economic behaviour. Investors are less likely to sell assets, even when a better opportunity exists, because the tax penalty eats into any marginal benefit. This 'lock-in effect' reduces capital mobility and keeps assets in lower-value uses. Government loses too – less productive investment means less income to tax.

For small business owners and entrepreneurs, the tax adds to the disincentive to strike out alone. Why risk capital and personal security if success is penalised more heavily than employment?

And for property investors – already treated less favourably than homeowners, who pay no CGT at all – the disincentive is stark. The resulting decline in rental supply pushes up rents and reduces housing choice.

Even under the best-case scenario, abolishing the CGT discount might raise an extra $10 billion a year. But that's optimistic. In a typical year like 2020-21, the extra take would likely be closer to $6-7 billion – just two years' worth of growth in the NDIS.

That's hardly a solution to the structural deficit. Nor is it a fair or efficient way to raise revenue.

Taxing capital gains more heavily won't bridge the deficit. It will penalise investment, discourage risk-taking, and introduce costly distortions. It would be a political betrayal – and an economic mistake.

Jim, step back from the brink. Australia needs more capital, not less – and more investment, not punishment.