Service or speculate?

Last week ABC's Radio National breakfast show did a neat report on the cost of housing, giving an overview from a number of different perspectives. Your correspondent offered one of them, but I'll draw your attention particularly to another.

Mr Saul Eslake, previously chief economist of ANZ, stated clearly one aspect of the madness of how we tax housing – but if Eslake wasn't clear enough, see the front page of today's Herald for an illustration. This is the story of a house in the inner Sydney suburb of Annandale, purchased for $1.3 million in December 2008, and 15 months later for $1.8 million. And what did the owner do to get this cool $500 000 profit? Says the agent:

''They just repainted, recarpeted, tidied up the garden and made a slight improvement to the kitchen area. That's pretty much it.''

Alternatively, they might have actually done something useful and rented the place out. Doing so might have generated an income for the owner of, I don't know, $50 000 for the fifteen months (it's a pretty schmick house).

And as Eslake says, this income would be taxed at the owner's top marginal tax rate. But the owner's profit from doing nothing productive and simply on-selling will be taxed at half that rate, thanks to the capital gains discounting provisions introduced by Treasurer Costello in 2000... and now retained by Treasurer Swan in the face of alternatives suggested in the report of the Henry Review.

What to do: provide a valuable service, or speculate? The tax system says, resoundingly: speculate.