A couple of weeks ago I wrote about a major flaw in the government's proposed capital gains tax reforms.  Using a four share portfolio, I showed how replacing the current 50% CGT discount with inflation indexation could increase the amount of tax paid by investors by ~61%. The example was deliberately simple because it helped illustrate the mechanics of the problem... but some readers reasonably questioned whether a portfolio containing one extreme winner, two mediocre performers and one complete failure was representative of how Australians actually invest in shares. So I decided to test the CGT changes using a portfolio based on actual investor behaviour rather than relying on a hypothetical portfolio. I analysed the 20 most popular ASX shares and ETFs purchased six years ago in April 2020. Despite analysing a completely different portfolio based on actual investor behaviour, I arrived at a similar conclusion. The proposed indexation model increased taxable gains by ~82%. The government's stated aim is to improve fairness and encourage investment into housing. But if the practical effect is to penalise diversified investors and significantly increase tax on ordinary Australians who invest patiently over decades, the reforms risk creating distortions far greater than those they seek to address. Policymakers should carefully consider whether a tax system that increases tax for a typical long term investor by more than 80% is really achieving its intended objective. A related question is why any rational investor would choose to invest in direct shares at all under this regime? If successful portfolios are taxed much more heavily and unsuccessful ones receive less recognition for their losses, the after tax risk adjusted return from direct share investing becomes highly unattractive. Full analysis is here: blog.stockspot.com.au/shares…

“Capital gains are uncertain and require the taking of risk. Employment income is generally predictable, certain and risk free. It’s like the difference between equity and debt, one is high risk but potentially high reward (or no reward) while the other offers certainty and thus no upside or downside. No economically literate person suggests the cost of debt should be the same as the cost of equity. The Albanese-Chalmers taxation principle ignores human nature. Why would any sane person invest in a risky venture if the taxman treats you the same as if you invested in a risk free venture? And yet the two most senior politicians responsible for the Australian economy are touting as “reforms” the proposal that real capital gains be taxed at the same rate as income. Without some incentive to take risk or to innovate by investing capital, new business growth dies, and the economy suffers. If you doubt this, talk to some of the venture capitalists and start-up entrepreneurs who are dismayed by the budget changes to capital gains tax.” Brilliantly written by @jkalbrechtsen

The big surprise in last night’s Federal Budget wasn’t just the move from the 50% CGT discount to inflation indexation (which was already flagged weeks ago) ... it was the hidden minimum effective 30% CGT floor layered on top. That’s an extraordinary change because it effectively moves long term capital gains from being taxed more concessionally than earned income to being taxed more heavily! In practice it pushes Australia’s effective tax rate on capital returns to at least double comparable global markets, making Australia completely uncompetitive for growth investments. That fundamentally changes the economics of long term investing, entrepreneurship, innovation capital, R&D and high growth assets where much of the return comes from long term capital appreciation. The impact won’t just fall on wealthy Australians. It will also hit many lower and middle income Australians who rely on long term capital growth from shares and ETFs to help fund retirement outside super. If long term investing becomes less rewarding after tax, more households will choose to consume rather than invest, adding even more pressure to inflation and interest rates over time. It will also affect thousands of small business owners who spend decades building businesses like physio clinics, dental practices and family businesses expecting the eventual sale to help fund retirement. If a much larger share of that sale proceeds disappears in tax, more Australians may end up relying on the age pension instead. The Government also seems to underestimate how sensitive capital and talent are to tax settings. If the after tax reward for investing, building businesses and taking long term risks falls by this amount, capital doesn’t just magically stay put. Some of it will move offshore, some investors simply won’t sell assets and others will reduce risk taking altogether. Ironically, that may mean the actual tax receipts end up far lower than Treasury expects, while Australia becomes less internationally competitive for investment, entrepreneurship and innovation. It’s a tax policy that doesn’t properly consider what should be obvious second and third order consequences for capital flows, entrepreneurship, retirement funding, inflation and long term economic competitiveness. And how exactly is a modest fall in house prices (Treasury modelling suggests house price growth will reduce by 2%) supposed to help younger Australians if rental supply dries up because private property investors leave the market? What’s the long term plan for housing availability if the economics of providing rental housing become completely unattractive? This doesn’t seem like a serious long term economic growth strategy. We’ll be updating our CGT change calculator today to reflect: • the new transition timeline • the post 1 July 2027 split treatment • the surprise minimum 30% CGT floor stockspot.com.au/cgt-calcula… In the meantime, here are our thoughts on what these changes mean for investors: blog.stockspot.com.au/federa…