The clearest sign the government’s tax reforms have failed may not be a falling sharemarket as investors baulk at the potential for significantly higher capital gains tax.
It could actually be the complete opposite.
That’s because these changes could simultaneously discourage risk-taking, reduce investment in growing businesses and weaken long-term economic growth while pushing the Australian sharemarket sharply higher.
In fact, it’s entirely plausible that the reforms contribute to the ASX 300 rising 40-50 per cent over the next few years.
If that happens, some will point to the rising market as proof the policy was a success. But that would be the wrong conclusion.
To understand what’s going on, we need to focus on dividends.
CGT-driven shift to dividend stocks
The Australian sharemarket offers a grossed-up dividend yield of about 4.1 per cent, supported by companies paying out roughly 53 per cent of earnings (known as the payout ratio).
Under the proposed reforms, the tax system would become more favourable towards distributing profits than growing them. That’s because many investors would face a minimum effective tax rate of 30 per cent on capital gains, while franked dividends carry credits for company tax already paid, meaning investors generally only pay the difference between the company tax rate and their own marginal tax rate, and in some cases receive a refund.
Public company boards ultimately answer to shareholders. As shareholder preferences shift towards fully franked dividends, boards will come under pressure to distribute a greater share of profits rather than retain them for future growth. If investors place a higher value on dividends than future growth, management teams will have a strong incentive to increase payout ratios.
If the market payout ratio increased from 53 per cent to, say, 70 per cent of profits, a market currently offering a grossed-up yield of 4.1 per cent would suddenly be offering a grossed-up yield of roughly 5.4 per cent.
A higher yield makes Australian shares more attractive relative to cash, government bonds and international shares. Investors seeking income would likely bid up share prices until the yield falls back towards a level they consider appropriate for the risks involved.
For the market’s grossed-up yield to fall from 5.4 per cent back to 4.1 per cent, share prices would need to rise by about 32 per cent.
In other words, sharemarket investors could become wealthier even as the economy becomes less productive underneath them.
The role of interest rates
The second part of the story is interest rates.
If higher dividend payout ratios contribute to less business investment, slower hiring and weaker economic growth, interest rates are also likely to be lower than they otherwise would have been.
That matters because income-producing assets are valued relative to the risk-free rate. When cash and bond yields fall, investors are generally willing to accept lower yields from shares and share prices must rise.
A fall in the market’s required yield from 4.1 per cent to 3.5 per cent would imply share prices roughly 17 per cent higher.
Combined with the potential uplift from higher payout ratios, it’s not difficult to construct a scenario where the ASX 300 rises 40-50 per cent despite weaker underlying economic growth.
A short-term sugar hit
But what’s good for a portfolio in the short term isn’t always what’s good for the economy over the long term. Any market rally driven by higher dividend payouts, lower interest rates and weaker economic activity would amount to little more than a short-term sugar hit.
The combination of a stronger preference for dividend income, a reduced appetite for risk and the diversification penalty embedded in the reforms will create a powerful vacuum of capital out of small caps, start-ups and growth businesses, and into established dividend payers.
Capital that might once have funded a biotech start-up, software company or critical minerals explorer will instead flow into banks, toll roads, utilities and other mature businesses offering franked dividends.
That’s bad news for innovation, entrepreneurship and productivity growth. But it could be highly supportive of the ASX 300 and ETFs that track the broad market, because capital would be funnelling in the largest dividend-paying companies that already dominate the index.
The Australian sharemarket is already dominated by big banks, BHP, REITs, supermarkets and infrastructure businesses. If investors increasingly favour dividends over growth, these companies are likely to attract a disproportionate share of new capital.
The result could be a self-reinforcing cycle. Capital leaves smaller growth businesses in search of dividends and tax efficiency. Large dividend-paying companies receive more inflows. Their market capitalisations rise and their index weights increase. Broad market ETFs then automatically direct even more money towards them. Meanwhile, the businesses most likely to drive future innovation and productivity find it harder to attract funding.
And that’s the paradox.
The reforms could simultaneously weaken business investment, discourage risk-taking and slow productivity growth while sending the Australian sharemarket sharply higher. If ETFs tracking the ASX 300 are 50 per cent higher in a few years’ time, supporters may point to that as evidence of success. But the more important question will be why the market rose.
Was it because Australian businesses became more productive and innovative? Or because the tax system encouraged investors to favour dividend income over productive investment and companies to distribute profits rather than reinvest for future growth?
If it’s the latter, that’s not much to celebrate.
This article is adapted from an opinion piece originally published by The Australian – “Tax reforms could fuel dividend-led market boom at the expense of economic growth“ (23 June 2026).
