The taxation of capital gains of individual taxpayers continues to be an area of Australian tax law that is of policy interest and a candidate for reform.
The approach of policymakers in introducing a comprehensive CGT in the 1985-86 tax year was to tax net capital gains at full marginal rates, with an inflation adjustment to the cost base of capital gains assets. The enactment of the 50% CGT discount in 1999-2000 was a substantial change to that regime, which effected a reduction in the tax rate on discount capital gains to half the marginal rate.
The CGT discount has been characterised as a generous concession that benefits high income taxpayers disproportionately and which compromises the policy intent of a comprehensive CGT, which was enacted primarily for equity reasons.
In light of this background, we undertook an analysis of individual taxpayer data to gain some insights into the characteristics of taxpayer groups who have capital gains. The results indicate where the benefits of the 50% CGT discount flow and may be used to inform future changes to the taxation of capital gains.
Cluster analysis
In our study, we focussed our attention on the small proportion of taxpayers who have capital gains in a given tax year. Specifically, we analysed individual taxpayer data for the 2019-20 tax year in the 2% individual taxpayer sample file, as well as aggregate taxpayer data in Taxation Statistics.
We used the data mining technique of cluster analysis to organise the taxpayers with capital gains from the 2% sample file (19,925 taxpayers) into six distinct clusters. The cluster analysis drew on 27 variables from the 2% sample file, and its purpose was to detect patterns or associations in the data.
In the study, each taxpayer (observation) starts in its own cluster; and they are iteratively merged into larger clusters by the agglomerative nesting (AGNES) algorithm based on their similarity. The final number of clusters is not specified in advance and the number of taxpayers in each cluster can differ.
Six distinct groups
Table 1 highlights the defining feature of each of the six clusters and it includes the mean levels of total capital gains for each. A table that includes the detail on all 27 variables for all clusters is set out in our journal article.
Table 1: The clusters and their defining characteristics (all amounts reported are mean levels)
There was a notable difference between clusters 1-3, when compared to clusters 4-6.
Specifically, the former group comprised 99.11% of taxpayers with capital gains, and the proportion of all capital gains in this group was 71%. The latter group (the 0.89% of taxpayers with capital gains who comprised clusters 4-6) reported the remaining 29% of capital gains.
The taxpayers in Clusters 4, 5, and 6 had mean levels of total capital gains of $1.682 million, $705,652, and $732,652 respectively. These are significantly higher mean levels of total capital gains than for Cluster 1 ($39,194), Cluster 2 ($19,041) and Cluster 3 ($12,201).
What this means
It is accepted, by both supporters and detractors, that the 50% CGT discount is a feature of the personal income tax system that runs counter to the principles of vertical and horizontal equity. Our analysis extends upon this by highlighting the inequities that arise within the population of individual taxpayers with capital gains.
The results of our analysis show that the benefit of the 50% CGT discount is highly skewed towards taxpayers in clusters 4-6, who represent 0.89% of individual taxpayers who realise capital gains, and approximately 0.06% of the individual taxpayer population. That is, the preference for capital gains is enjoyed disproportionately by a miniscule group of wealthier taxpayers.
As has been suggested since its introduction, there is no credible tax policy reason for subjecting capital gains to a lower rate of tax. Our study demonstrates that the benefits of the tax preference flow to a very small group of taxpayers, with mean levels of taxable income between $1.393 million and $1.996 million. The ability of this group of taxpayers to pay tax at normal marginal rates is difficult to dispute and, given the 50% CGT discount is a sizable tax expenditure with an estimated forgone revenue cost of $23.69 billion in 2022-23, it would seem an obvious area for reform.
Reform of the 50% CGT discount would be beneficial from the perspective of tax policy overall, as well as for most taxpayers.
Journal article
Minas JP., Minas, J. and Lim, Y. (2023), A cluster analysis of individual taxpayers – what are the characteristics of taxpayers who realise capital gains? Australian Tax Forum, 38(2): 245-265.
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