IT IS time to kill negative gearing.

Paul Keating got rid of it once, when he was Treasurer, but he brought it back to see if it might encourage cheaper rent.

Instead it put a rocket under speculative housing investment and helped lift house prices, which made rents go up. It has been a dud and it needs to come to an end.

But negative gearing is not the only bad guy in the story. Even if it is killed, a bigger villain is likely to slink away.

Capital gains tax has been a huge factor in rising house prices, and it brings the richest parts of society even more advantages than negative gearing

The next two graphs show who benefits from each policy and if you think the negative gearing one looks skewed to the rich, the capital gains tax discount graph is going to blow your mind.

HOW THE HECK DOES IT WORK?

If you make a profit onselling an investment that’s called a capital gain. And yep, you would pay tax on it like income … if you owned the investment for less than a year. If you’ve owned it for more than a year, you get a big tax discount of 50 per cent.

So If I buy a painting for $1000, and sell it for $2000 two years later, I made $1000. But I only pay tax on $500. So I pay less tax on investing than if I earned $1000 cleaning toilets!

Why does the tax system reward investment like that?

Partly it’s because of inflation. If you own a painting for 35 years and it goes up by two per cent a year, it doubles in value (roughly). But that’s not a “real” profit, because inflation also went up, say, two per cent a year. The buying power of $2000 when you sell it is equal to $1000 at the time you bought it, so taxing that $1000 as profit is silly.

The capital gains tax discount helps compensate for this problem. It says, ‘hey, we know it’s unfair to put a huge capital gains tax on things that partly went up because of inflation. You can pay a bit less.’

But it’s a stupid way of doing it, because the full discount kicks in after just a year, so it gives the same advantage to someone whether they own an asset for a year and a day or for 50 years.

A CAPITAL IDEA

Labor has a policy for changing CGT. But its simplistic policy to cut the CGT discount from 50 per cent to 25 per cent is even more unfair for anyone who plans to own an investment for a really long time.

A better idea is to cut to the chase and tax profit above inflation. And — it turns out — we did that for a while back in the 1980s and 1990s. But then in 1999, the rules were changed. We moved to the current 50 per cent discount rule on capital gains tax.

Now, I don’t want to say that this one little change is responsible for the rise in house prices, but check out what happened after 1999.

If we get rid of negative gearing and nothing happens to house prices, it will be even more evidence capital gains tax is a major cause of our house price explosion.

And then the urgency to fix it will be even more intense.

Jason Murphy is an economist. He publishes the blog Thomas The Thinkengine. Follow Jason on Twitter @Jasemurphy