Labor hasn't got a capital gains tax policy yet, but it's already making the case

By the most technical of technicalities, we still don't actually know that Labor is planning to lower the capital gains tax discount. But let's not be silly: we pretty much know.

Treasurer Jim Chalmers has stopped pretending, saying on Sunday he was "working up a number of tax reform options" for cabinet, specifically on housing, and specifically to improve "intergenerational fairness".

Finance Minister Katy Gallagher has stopped pretending too, joining the dots on Tuesday: "We are interested in responding to some of the intergenerational issues around housing. Capital gains tax comes up as one of those issues."

There is still a little bit of pretending in the final report from the senators who have been, by happy coincidence, looking into the discount over the last few weeks. The two Labor backbenchers on the committee were careful in their comments, deferring to cabinet.

But the committee's "findings" look very much like talking points for a not-yet policy. Senators observed the discount, which reduces the tax paid on the proceeds when an investment property is sold, "can distort decision-making and incentivise tax planning".

They added that the discount has "skewed the ownership of housing away from owner-occupiers and towards investors", and that its benefits are "unequally distributed" with implications for, you guessed it, "intergenerational inequality".

This may not have been a Labor-led committee — it was chaired by Nick McKim of the Greens. But these were Labor words, or at the very least words Labor approved, no doubt cleared through Chalmers' office as is standard practice for these reports.

Just minutes before the report was tabled, Chalmers told reporters the government's polices "haven't changed" and that "further steps would be a matter for the cabinet".

But with so much smoke, his weeks-long cryptic commentary on the subject would look very strange indeed if he does not now start a fire. The most useful guessing game from now to May is not whether the cabinet will decide to proceed, but how.

Housing is all* about supply

The committee report offered a few clues about that.

Given that ministers have stated that any tax reform must improve housing affordability, one puzzling question has been how capital gains tax reform could fit this description when, in the view of Treasury, it would have "a relatively small impact" on house prices.

In fact, it is the view of the department and the Grattan Institute that a less generous discount would reduce housing supply — effectively because "if you tax something more, you get less of it," as Liberal Leader Angus Taylor has put it.

According to Grattan, the effect would be almost vanishingly small, with 10,000 fewer homes built over five years. But anything that cuts against the government's argument that boosting supply is the solution to the housing crisis is unlikely to be suitable.

The implication is that any change would need to be pro-supply, even if only a little. An obvious way to do this would be to keep the generous treatment for new builds, but rein in the discount for those who purchase old homes.

The committee findings seem to prepare the ground for something like this, noting that "existing housing stock makes up a substantial share of capital gains that benefit from the capital gains discount".

The findings even suggest the discount might "distort" investment towards old homes over new ones. It's not entirely clear why this would be, given the discount is the same for all homes. A different rate for new homes would create a distortion, not remove one.

But it might be a distortion that suits Labor's aims if it encourages more building. And since 92 per cent of investors buy old homes, carving out new ones may not make much difference to how much money is raised by any tax changes.

And apart from any change to housing supply or house prices, any tax change would likely boost home ownership rates by making housing less attractive to investors, who currently own one in three Australian homes.

Reduce the discount to what?

Perhaps the most important design question is what rate to choose instead of the current 50 per cent discount.

The numbers 33 per cent and 25 per cent have been thrown around as speculation. But just like 50, these are arbitrary numbers. Another option would be to return to the way the tax worked before 1999.

Back then, the discount was equal to however much of the gain in the asset's value was due to inflation. The idea was that inflation was not a real gain and should not be taxed.

The 50 per cent discount "overcompensates" most people for inflation. A 25 per cent or 33 per cent discount might be closer to the mark for some, but would also leave others "under-compensated". A strict calculation would hit the nail on the head for everyone.

One drawback is that it is harder to calculate than a flat rate. But former Treasury Secretary Ken Henry, the e61 Institute's Michael Brennan, and officials from the Australian Tax Office all told the committee this was not a significant obstacle.

But the e61 Institute also pointed out that inflation was not the only reason for the 50 per cent discount. The other was to minimise the "lumpiness" that the capital gains tax can create, a point also emphasised by Treasury.

Capital gains tax is paid when an asset is sold. While some investors with large portfolios would sell assets regularly, for many people the sale of a property is a rare event. And when they sell, their incomes for that year shoot up.

This might take someone into the top tax bracket, and see them pay a top rate 45 per cent when they would have paid a lower rate if they earned exactly the same amount of income spread out over several years.

By halving the tax paid on the capital gain, a 50 per cent discount smooths this out somewhat, but a lower discount might not. The e61 Institute recommended smoothing out the tax, perhaps over five years rather than one, to address lumpiness.

Treasury officials have been at pains to point out the lumpiness issue not only in the committee but when asked about capital gains tax in Senate hearings.

Grandfathering or grandchildren-ing?

The last important design question for the government is how it would transition from the old policy to the new policy. When Labor last proposed reforming the discount in 2019, the policy was "fully grandfathered".

That meant that any properties purchased before the implementation date would be exempt. This was a political concession designed to head off any accusation that Labor was "changing the rules" on people who had bought assets with a given tax in mind.

But it also means the policy raises less money, doing little either to repair the budget or fund further income tax cuts. And importantly, it would also do less to repair the intergenerational divide that has accumulated over decades.

ACOSS has proposed a phase-in over five years instead, and independent MP Allegra Spender has proposed making the new regime apply to new gains only, even if they are on old properties.

The Greens' McKim, who as the party's economic spokesperson will be a key figure for the government when it comes to negotiating any changes through the parliament given the Coalition's likely opposition, has hinted that a phase-in is a top priority.

"Grandfathering changes would exacerbate poor intergenerational outcomes. To ensure a significant release of housing is made available for renters to buy, hard limits and a phase out of existing arrangements must be part of any [reforms]," he wrote.

The Labor-Greens housing wars were a dominant feature of the last term of parliament but have since gone dormant. If Labor wants to pursue capital gains tax changes, the minor party may ask it to choose between grandfathers and grandchildren.