Reducing the capital gains tax discount would make the tax system fairer, raise much-needed revenue and have little effect on housing supply, given how constrained that supply already is.

A fundamental principle of taxation is that it should be fair. To the extent that people gain from extra income, that income should be taxed at the same rate whatever form it takes.

After all, the benefits of an extra dollar of income is the same whatever its source. For example, $100 of wages provides the same benefits and capacity to pay tax as $100 from a bonus, a contract payment or dividends.

The only reason why capital gains are different is that they are only taxed when realised, and that means that they are typically accumulated over several years, whereas all other income is taxed in the year it is generated. But because capital gains have typically been accumulated over several years that means that at least part of that gain reflects the impact of inflation, and to the extent that the capital gain matches the inflation impact then the taxpayer is actually no better off than when they made the original investment.

That is the reason why when capital gains taxation was originally introduced back in 1985, the then Labor Government determined to only tax real capital gains after deducting the estimated impact of inflation.

However, it was later claimed that estimating the impact of inflation was too difficult. So instead, the Howard Government introduced a discount factor for capital gains taxation of 50 per cent. Such a high discount rate could have been justified if inflation had been very high – say 7.5 per cent or more – but this has not been the case, with the average rate of inflation being inside the Reserve Bank’s target range of 2-3 per cent for decades.

Accordingly, a lot of economists are calling on the government to reduce the capital gains discount to around 33 per cent. The Treasurer, Jim Chalmers, has indicated that he is amenable to considering this option in his next budget, and it seems very likely that it will have the support of the Greens.

However, the new Leader of the Opposition, Angus Taylor, and the new Opposition Treasury spokesman, Tim Wilson, have made clear that they will oppose any reduction in the capital gains discount from 50 per cent. They argue that taxing capital gains more heavily will especially damage the residential property market. Something that no one would want in the middle of the present housing crisis.

Taylor and Wilon’s argument is that if the after-tax return to investors in the property market is reduced then they will reduce their investment, residential property prices will fall, and consequently the supply of housing will be less.

In a very simple economic model where supply is highly elastic it is true that supply will tend to fall in response to lower prices that results from less demand. However, the supply of housing in Australia is almost totally inelastic, and when the supply is very inelastic, quite big changes in prices have little or no effect on the supply.

Indeed, the reason why house prices are so high relative to incomes is because the supply of additional housing is so limited, mainly by planning restrictions. These restrictions then mean that the supply of housing is very inelastic. If one type of investor withdraws because their return is less, they are quickly replaced by another.

Furthermore, that is precisely why many housing policy experts are calling for an increase in the taxation of capital gains. They expect that this will have no impact on housing availability, but at the margin will redistribute who gets the available housing in favour of new homeowners and away from investors.

While both Taylor and Wilson would like us to believe that they are excellent economists, their opposition to capital gains tax reform because of the alleged impact on housing supply tells us is that they are really economic dolts.

Sure, in their Economics 1.01 textbook, supply and demand are assumed to be highly elastic and therefore responsive to changes in prices. But in the real world, housing supply is extremely unresponsive to price changes, and therefore inelastic, because planning controls limit that supply to well below the potential demand if the controls were relaxed a bit.

Reforming the discount on capital gains for taxation purposes would result in a fairer tax system without any damage to the economy. In addition, it would raise some more revenue which the budget sorely needs.