... That's Lending
Negative gearing - real value or just a tax break for investors?
Australia is one of only a few developed nations that still allows negative gearing, which was accelerated by the Howard Government’s 1999 decision to tax capital gains at half the rate applicable to other income (instead of taxing inflation-adjusted capital gains at a taxpayer’s full marginal rate).
Negative gearing has become “a vehicle for permanently reducing, as well as deferring, personal tax liabilities. And the availability of depreciation on buildings adds to the way in which ‘negative gearing’ converts ordinary income taxable at full rates into capital gains taxable at half rates” - Saul Eslake.
The Grattan Institute and Saul Eslake see no policy rationale for negative gearing. It costs taxpayers a fortune – roughly $5 billion in revenue foregone. It does nothing to increase the supply of housing – “92% of all borrowing by residential property investors over the past decade has been for the purchase of established dwellings, as against about 72% of all borrowing by owner-occupiers”. It increases investor demand and prices. And it does nothing to improve rental availability or affordability.
Supporters of ‘negative gearing’ argue that its abolition would lead to a ‘landlord’s strike’, driving up rents and exacerbating the existing shortage of affordable rental housing. They repeatedly point to what they allege happened when the Hawke Government abolished negative gearing (only for property investment) in 1986 – that it ‘led’ (so they say) to a surge in rents, which prompted the reintroduction of ‘negative gearing’ in 1988.
This assertion may not be actually true. If the abolition of ‘negative gearing’ had led to a ‘landlord’s strike’, as proponents of ‘negative gearing’ repeatedly assert, then rents should have risen everywhere (since ‘negative gearing’ had been available everywhere). In fact, rents (as measured in the consumer price index) only rose rapidly (at double-digit rates) in Sydney and Perth – and that was because in those two cities, rental vacancy rates were unusually low (in Sydney’s case, barely above 1%) before negative gearing was abolished. In other State capitals (where vacancy rates were higher), growth in rentals was either unchanged or, in Melbourne, actually slowed (see Chart 7).
However, notwithstanding this history, suppose that a large number of landlords were to respond to the abolition of ‘negative gearing’ by selling their properties. That would push down the prices of investment properties, making them more affordable to would-be home buyers, allowing more of them to become home-owners, and thereby reducing the demand for rental properties in almost exactly the same proportion as the reduction in the supply of them. It’s actually quite difficult to think of anything that would do more to improve affordability conditions for would-be homebuyers than the abolition of ‘negative gearing’.
Eslake also notes that there is no evidence to support the claim that negative gearing results in more rental housing being available that would otherwise be the case. Most other ‘advanced’ economies don’t have ‘negative gearing’: yet most other countries have higher rental vacancy rates than Australia does.
In the United States, which hasn’t allowed ‘negative gearing’ since the mid-1980s, the rental vacancy rate has, in the last 50 years, only once been below 5% (and that was in the March quarter of 1979); in the ten years prior to the onset of the most recent recession, it has averaged 9.1% (see Chart 8 above).
Yet here in Australia, which does allow ‘negative gearing’, the rental vacancy rate has never (at least in the last 30 years) been above 5%, and in the period since ‘negative gearing’ became more attractive (as a result of the halving of the capital gains tax rate) has fallen from over 3% to less than 2%. During that same period, rents rose at rate 0.8 percentage points per annum faster than the CPI as a whole; whereas over the preceding decade, rents rose at exactly the same rate as the CPI.
Similarly, countries which have never had ‘negative gearing’ – such as Germany, France, the Netherlands, the Nordic countries and (low-tax) Switzerland – have much larger private rental markets than Australia.
Eslake also debunked claims that removing negative gearing would create distortions in the tax system. Some supporters of negative gearing also argue that since businesses can deduct all of the operating expenses they incur (including interest) against their profits in order to determine their taxable income, and can also ‘carry forward’ net losses incurred in any given year against profits earned in subsequent years so as to reduce the tax otherwise payable, it is only ‘fair and reasonable’ that investors should be able to do the same.
There are two flaws in this argument. First, a large part of the appeal of ‘negative gearing’ comes from the way in which it allows income which would otherwise have been taxed at the investor’s marginal rate effectively to be converted into capital gains, which are taxed at half the investor’s marginal rate. Businesses – if they are incorporated, as most businesses these days are – can’t do that. Companies aren’t eligible for the 50% discount on tax payable on gains on assets held for more than one year.
Second, while individuals are allowed to deduct expenses incurred in connection with producing investment income from their taxable income, they aren’t allowed to deduct many types of expenses incurred in producing wage and salary income. To take an obvious example, wage and salary earners aren’t allowed to deduct the cost of travelling to and from work; nor are they allowed deduct child care expenses.
Or, to take another example which may be an even closer analogy with ‘negative gearing’ for investment purposes, individuals aren’t allowed to deduct interest on borrowings undertaken to finance their own education as a tax deduction, even though that additional education may contribute materially to enhancing their future earnings – and even though any such additional future earnings will be taxed at that individual’s full marginal rate, as opposed to half that rate in the case of capital gains on an investment asset.
It’s a controversial issue and one all too well remembered by Canberra when then Federal Treasurer Paul Keating attempted to remove it in 1988 but quickly reversed that decision after some poor polling and public outcry. It’s an issue with current budgetary pressure that will keep popping up.