The 50 per cent capital gains tax discount departs from the original purpose of taxing real gains, entrenches inequality and unfairly advantages wealth over work.

When Paul Keating introduced Capital Gains Tax in 1985, he achieved one of the great tax equity and integrity reforms in Australia’s history.

He introduced the tax based on the principle that only real capital gains, that is gains after taking account of inflation, should be liable to taxation.

That principle was right then; it remains right today.

Unfortunately, the implementation of the indexation of the original cost to account for inflation became complex and unwieldy. Accountants understood it, but taxpayers didn’t.

The case for simplification was strong.

Peter Costello articulated the case for simplification well in 1999, but his implementation of the simplification was absurd.

By introducing a one-off 50 per cent discount after the capital item has been held for twelve months, he created a significant distortion and reduced the equity of the original Keating reform.

How does it make sense to pay 100 per cent tax on an item if you sell it in the twelfth month after purchase but only 50 per cent in the thirteenth month?

And for many years the seller will gain an unreasonable and unjustifiable advantage over wage and salary earners who pay tax on all their income.

The Grattan Institute has calculated, based on government data, that the CGT discount mainly benefits the already wealthy. The wealthiest 20 per cent of Australians receive nearly 90 per cent of the CGT discount.

The Institute, in a Senate Committee submission, also argues that the discount is a big reason why older Australians pay a lower tax rate on their income than younger Australians still working.

This is an important matter of intergenerational equity without looking at the implications of the CGT discount on housing.

What should Costello have done?

The best option would have been to introduce a sliding scale of discount based on the RBA’s target for inflation.

This could be 2.5 to 3 per cent per annum, or of you want to put a little allowance to take into account the occasional overshooting of the target band it could be as high as 5 per cent.

This would have meant taxpayers paying tax on the current rate of 100 per cent of their capital gain in the first year, 95 per cent in year two etc. It would still have been possible to have stopped the discount at 50 per cent in the tenth year and thereafter or to have gone on to 25 per cent after 15 years.

However, it is too late to revert to that option. It would mean increasing the discount for some with no discernible benefit.

But there are feasible ways forward.

We could go back to indexation, but nobody wants to see unnecessary complexity introduced into the tax system.

A possible variant of the better initial proposition would be to scale the discount down from 50 per cent to 25 per cent over five years and maintaining it at 25 per cent thereafter, however long the asset is held.

I have no idea what reform, if any, the Treasurer is considering to CGT. It will take political courage to take on the vested interests who benefit from the current excessive discount.

You can assume that the wealthy beneficiaries will not give up their benefit easily. And they will once again seek to conscript the poor in their defence. “Mum and dad” investors will be front and centre of the arguments, hiding the fact that the principal beneficiaries, the wealthiest investors will be hiding behind them.

Early indications are that the Liberals will support maintaining the current excessive discount. I assume their donors may insist upon it.

Logic and equity both point in the same direction: a discount based on real gains not an artificial excessive discount which distorts investment decisions and robs hard working and younger taxpayers.

That can be the basis for a compelling argument, but it will not be an easy political contest to win.