Labor's capital gains proposal flawed but better than what we have, economists tell inquiry

Labor's proposal to overhaul negative gearing and the capital gains tax has some design flaws but is better than the current system, according to several leading economists who appeared before a parliamentary inquiry on Monday.

The first day of hearings was shaped by warring contributions from elated progressive groups, who argued the tax package would improve generational fairness, and furious business groups who warned that it would chill investment.

But a handful of independent economists invited to address the Senate's economics committee came down in favour of the government's proposal to replace the flat 50 per cent capital gains tax discount with a discount linked to inflation, despite misgivings.

Michael Brennan, a former Productivity Commission chair and chief executive of the e61 Institute, said there was "scope for improvement" and disagreed with the decision to impose a 30 per cent minimum tax on discounted gains, among other things.

But he called the discount a "principled approach" and said it should apply to a broad range of assets, not just property as some have suggested. "If you ask me what does an ideal capital gains tax system look like, it has inflation indexation at its heart," he said.

Michael Brennan of the e61 Institute supported an inflation-based discount despite some criticisms of the government's chosen approach. ( Supplied: Productivity Commission )

Independent economist Saul Eslake also objected to the 30 per cent minimum but said the proposal would improve equity in the tax system by bringing the tax treatment of investment income closer to the tax treatment of wage income.

"Why should people earning a similar amount of income be asked to contribute different proportions of that income to the cost of providing schools, hospitals, policing and other public services simply because they earn it in different ways?" he asked.

Robert Varela from the ANU's Tax and Transfer Policy Institute, which often collaborates with the Treasury, said Australia's current arrangements for taxing investment income were "a mess" and this was "a step in the right direction".

"They remove some but not all of the distortions across investment types, they remove some but not all of the margins for tax planning, and they remove some but not all of the incentives for leveraged investment," he said.

Government grapples with business fury

Treasurer Jim Chalmers is consulting with business groups on possible carve-outs to the new capital gains tax discount, likely to be granted for startups and perhaps some small businesses, whose owners pay capital gains tax when their businesses are sold.

This may go some way to pleasing the Tech Council, which will front the inquiry on Tuesday and argued in its written submission that the inclusion of startups "would disproportionately damage Australia's early-stage innovation economy".

But other business groups are outright opposed. An alliance of peak bodies, including the Business Council and the small business lobby COSBOA, signed a joint statement on Sunday urging the parliament to reject the bill and slamming the swift inquiry.

Those groups do not oppose the decision to apply higher taxes to established investment properties, or to restrict negative gearing for those properties, but told senators the application to other assets would harm productivity.

Bran Black of the Business Council said the changes would "reduce investment and add significant complexity and compliance burdens to an already complex system … at a time when Australia needs more investment, not less", saying the process was "rushed [and] piecemeal".

Skye Cappuccio of COSBOA said existing small business concessions, including an additional 50 per cent capital gains tax discount, had "not kept pace with modern business realities" and would exclude many business owners who would stand to pay more tax.

"For many small business owners, the business is not simply an investment, it is their life's work, their retirement plan and the result of years, often decades, of personal sacrifice," she said.

Skye Cappuccio of the small business council said the changes would hurt some business owners. ( ABC News: Callum Flinn )

Mr Chalmers, Prime Minister Anthony Albanese and colleagues have signalled openness to broadening small business concessions but have given no indication they plan to make any widespread changes.

Assistant Treasurer Daniel Mulino told the ABC on Monday changes would be focused on "special circumstances".

Mr Eslake supported a carve-out for startups, but Mr Brennan was less convinced. "As a matter of pragmatism, there may be a role for some carve-outs… [but] the intention is to try to maintain maximum consistency," he said.

"When we talk about startups where either the founder or some employees are effectively being paid in the form of shares… this is a substitute for wage income and it's actually not clear that we should be taxing that with a 50 per cent discount."

His e61 Institute col…