Grandfathering CGT discount would trigger 'terrible distortions': Ken Henry

"There's something special about the capital gain. It cannot be taxable in full. You therefore do not have a neutral tax outcome and so you're going to have a distorted property market," said Henry.

"The market is distorted because of the operation of the tax system and it happens purely because of the capital gains tax discount."

When questioned about whether the government should consider implementing transitional arrangements for reducing the discount, Dr Henry said he 'hated' the idea of grandfathering arrangements for existing investments.

"If I were in your position as Senators, that's something I would give a lot of attention to. I would think very deeply about that," he said.

"Everywhere I've seen it done [previously], it's caused all sorts of unintended consequences. [It can lead to] terrible distortions that put you on a bit of a slippery slope when it comes to policy making."

The Australian Financial Review reported yesterday that the government was currently considering a reduction in the discount to 33 per cent for housing investors, which would not apply retrospectively.

Henry said the superannuation space was a good example of some of the issues that can stem from grandfathering taxation arrangements every time changes occur.

Superannuation entered the Australian taxation system in the mid-1980s and by the late 1980s had its own special taxation arrangements, he explained.

"There were changes and further refinements of policy and at every step along the way the arrangements were grandfathered. So we had pre-1983 contributions and post-1983 contributions taxed differently and a whole swag of [different treatments]," he said.

"What that meant was that by the early 2000s, if someone retired and wanted to draw their money out of a superannuation fund, they would find or would be told by a tax advisor that depending upon when the contributions went into the superannuation fund, there were nine different taxation treatments that could apply."

Research undertaken by Treasury at the time indicated that the average retiree was paying approximately $8,000 in tax advice due to the level of complexity in the system, he said.

"The Australian Treasury then recommended that the government abolish benefits taxation for people aged more than 60," Henry said.

"So you can grandfather things thinking you're doing people a favour but the tax system itself is a pretty complicated animal and the more grandfathering you put into it, the greater complexity you add to it."