Room for Debate: Should negative gearing be abolished?

Room for Debate: Should negative gearing be abolished?
Room for Debate: Should negative gearing be abolished?

Negative gearing has worsened the housing crisis and cost taxpayers billions of dollars: Philip Soos

Few Australian housing policies are more contentious than negative gearing. Despite the publicity it has received and its popularity with government and property investors, little analysis of negative gearing can be found within easy reach, with much of it accessible only in academic journals. Only an occasional fragment is found in the mainstream media.

Australia’s policy on negative gearing is considered a sacred cow by investors and politicians, with Prime Minister Julia GillardTreasurer Wayne Swan and Federal Housing and Homelessness Minister Brendan O'Connor ruling out changes to this policy. The reason for this obstinacy is that negative gearing allows a property investor to deduct losses against the investor’s personal income of the investor at their marginal tax rate (MTR), a tax minimisation strategy adopted by 1,110,922 taxpayers who vote. Property is run at a net loss when interest payments and property-related expenses like repairs and maintenance exceed rental income.

The strong Australian economy has not experienced a recession since the early 1990s. This along with reduced personal tax burdens, real rising incomes, extensive propertysubsidies and tax breaks, and rapid increases in property values, delivered an economic environment conducive to negative gearing. From 1996 to 2010, housing prices surged by 130%, adjusted for inflation and quality.

The present housing and rental affordability crisis is placing tremendous financial stress on many Australians as housing and rental prices have outpaced wages, and provided the spark for the public to question the validity of subsidising investors, whether they choose to gamble on making a return by selling property at a higher price or eventually becoming cash flow positive when rents rise to exceed outgoings.

Despite the fact that negative gearing has existed for a long time, much assertion but surprisingly little evidence has been made to justify this policy across all classes of investment, whether it be shares, business, or property investment. The supporters of negative gearing provide negligible evidence to show that is it a sound policy.

Deductibility and tax minimisation under negative gearing

It is common sense that both businesses and investors should be allowed to deduct the costs directly incurred in making an income, but labour is unable to do so. A salaried employee incurs substantial costs in the course of earning a wage (for instance, accommodation, travelling to and from the workplace, and childcare) but government policy bars deduction of these costs against wages.

There is a double standard in operation here. From a distributional or equity perspective, this policy is biased towards the wealthy, as business and investment capital ownershipis concentrated into this class, which relies proportionately less upon wages.

The disparity between wage earners and investors is exacerbated when negative gearing is considered. The net income loss from an Investment Property reduces the investor’s personal tax liability, even though that loss was generated elsewhere. Earning a wage and earning income from an investment are two separate activities and should be treated as such. Business commentator Alan Kohler accurately summarised the inconsistency between investment and employment:

Five years ago treasurer Peter Costello told Australians: “Work for a living and we’ll tax you at close to 50 cents in the dollar; speculate and we'll only take 25 cents. Not only that but, as a special deal  while stocks last – we’ll pay half your speculating costs.”

To sum up this line of reasoning, investors are unduly advantaged by the present taxation arrangements relative to labor. Investment capital is overwhelmingly concentrated in the wealthiest households, who deduct investments costs against income generated, have the highest personal incomes and thus MTRs, can deduct investment losses against their personal tax liability (negative gearing), can carry forward losses and lower their effective MTRs.

Clearly, the tax system is biased towards the rich in terms of cost deduction and tax liability minimisation. Some of this bias can be reduced by maintaining consistency: labour should be allowed to deduct costs against wages but disallow negative gearing for investors.

 Increasing the rental stock and lowering rents

This is the primary argument in favour of negative gearing, that it provides an incentive to investors to purchase property for rent, thus increasing the supply of rental properties as a proportion of the total housing stock. As the reasoning goes, negative gearing holds rental prices down, benefitting tenants.

The evidence shows otherwise: 92% of residential property investment is for the purchase of existing dwellings rather than those newly constructed, meaning that former owner-occupiers and tenants have to purchase or rent elsewhere, respectively, thus resulting in little to no net increase in the supply of rental dwellings.

In the long term, it makes little sense for the supply of rental properties to increase compared to the total residential stock unless there is a profound upward swing in housing prices, with investors spurred into the market on expectations of making a substantial profit through realising capital gains upon sale. Accordingly, there is little incentive whenlong-term data from Australia and other countries shows that housing prices track inflation, despite numerous and ongoing booms and busts.

Negative gearing is also badly targeted as high-income professionals and millionaires also allegedly receive lower rents along with those who do need it. If policymakers are concerned about rental affordability, there are other options to pursue. The obvious candidate is the Centrelink Commonwealth Rent Assistance (CRA) scheme, a subsidy provided to low-income tenants.

The effects of quarantining negative gearing in the 1980s

The favourite scare story promulgated by the housing lobby is that when the Hawke/Keating government quarantined negative gearing during 1985-87, it caused rental prices to surge, quickly leading to its reinstatement. Fortunately, not only did the evidence refute this urban myth, it showed that negative gearing can be safely quarantined, if not abolished.

Rents rose in Perth and Sydney only, remained steady in Melbourne and Canberra, and fell in Brisbane, Adelaide, Hobart and Darwin. If the lobby was correct, quarantining should’ve adversely affected all capital city rental markets equally, not just two out of eight (even when factoring in a lagged response). There were confounding factors at work: rising interest rates, introduction of capital gains tax and a stock market bubble.

Oddly enough, while the lobby claims that quarantining will increase rents, the inverse is not considered: rents have escalated from 2006 onwards while negative gearing was in effect. Perhaps they could claim that rents would’ve been higher otherwise, but this is an ad infinitum argument, that is, negative gearing is not generous enough, so by increasing the scope of tax deductibility, it can serve to further constrain rents.

How much does negative gearing cost?

ATO data provides an estimate of the cost of negative gearing: in 1993-94 it was $850 million, fluctuating around the $1 billion mark over the next several years. As investors piled into the market, the cost rapidly escalated to a peak of $3.8 billion in 2007-08 before falling to $2.9 billion in 2009-10. Over the last 17 years, negative gearing has cost taxpayers an inflation-adjusted $33.5 billion (2012 dollars).

What to do?

Policy outcomes can be enhanced by quarantining negative gearing deductions to the purchase of newly constructed properties but not for established properties. It would be even better to remove it, as it makes little sense to subsidise property investors, regardless of the reasons for investment when there are better policies for helping low-income tenants.

Also, the negative gearing debate presupposes the existence of income taxation, which has no justification when evidence suggests that substantial amounts of tax revenue can be raised from far more efficient bases. Income tax is one of 125 burdensome taxes that productive individuals and business bear the brunt of.

According to the property lobby, it’s too dangerous to reform negative gearing, let alone abolish it. Fortunately, there’s no requirement for anyone to believe the lobby, given the weight of evidence against their assertions and the fact that they have enough conflicts of interest to fill a book.

Philip Soos is a researcher at the School of International and Political Studies at Deakin University.

Property investor Melanie Stott responds on page 2

 


Negatively geared property investors' contributions far exceed their tax breaks: Melanie Stott

 

OK, Philip Soos, I’ll bite.

Your article earlier this week on negative gearing has really ticked me off – and you can’t call me ‘the property lobby’ because I’m primarily a stay-at-home mum and a part-time journalist who used to run around after politicians for a living on the telly.

I’m a property investor too – thank goodness – but I should warn you that negative gearing on property investments all through my 20s certainly paved the way for me to spend the last seven or so years at home, raising two new little taxpayers. You’re right, what a dreadful policy, only benefiting “the rich”.

Who are these “rich” people?! Let’s find them and burn their houses down! They’re certainly the bad guys in your article, Mr Soos.

I could go on and on about the benefits of private investment in the property industry, despite your determination not to understand them. Try to think of it, if you would, as the original public-private partnership. Governments always have and always will need private citizens to invest in property, therefore providing a bigger rental pool for other private citizens. I hate to be all anti-progress about it, but there just isn’t a better way of doing it for a lazy $3 billion a year.

For this very large effort and ongoing commitment by the investors, there needs to be some sort of reward. People everywhere are great, but generally speaking in a business sense, people don’t do things for others for free.

The point of my response is not to get bogged down in policy debate. What I can tell you is what’s happening on the ground. Negative-gearing property investors are people, too. We’re workers, we’re mums and dads, we’re small business owners, and we’re taxpayers. We’re putting in the hard yards on the ground in the rental industry, and we’ve been doing it for years. Years and years.

I’ve renovated for profit every night and weekend for months, I’ve responded to tenant disasters in the middle of the night, I’ve picked up the pieces when good tenants go bad, I’ve experienced the best and worst of human nature as a self-managing lessor.

I’ve claimed losses, I’ve paid capital gains tax, I’ve put profits back into the economy and I’ve saved money to live off while our children are small. I’m also unlikely to need a pension in retirement –  here’s hoping, anyway. 

I’m far from a blight on society, Mr Soos, and I’m certainly not alone. As you’ve pointed out, there are well over a million property investors just like me. We’re a brave lot, and I firmly believe – no, I know, from experience – that our significant contribution outweighs our tax breaks.

Yes, some of us speculate, but many other taxpayers choose not to take on the associated risks and extra hard work. That’s their choice. That’s the difference.

By the way, your assertion that “a salaried employee” doesn’t get tax breaks associated with earning an income, is also wrong. Anyone who works or studies 20 hours or more per week gets 50% of their childcare costs back, paid quarterly, not annually in a tax return. I have no idea why you think “accommodation” is a legitimate work expense – it’s not. We all have to sleep somewhere, job to go to in the morning or not. That’s why it’s called a living expense.

Don’t get me started on your suggestion that perhaps negative gearing should only be applied to new property. Property investors are clever, but you won’t find many of us out and about on the weekends knocking up our own structures from scratch. Why would we want, as a nation, to hand a bigger break to the multinational building firms, which would no doubt whack a premium on top of their house-and-land or apartment package prices for investors, purely because they’d be the only products able to be negatively geared?

If you think there are any “millionaires” out there receiving low rents as a result of negative gearing, well, you’re wrong there, too. No property investor worth their salt sits down and works out the lowest rent they can charge based on what they’ll get back from negative gearing. It doesn’t work that way. It’s called market forces. I can ask $1,000 per week for a shack, but I won’t get it unless it’s comparable with other shacks on offer at the time. It’s unlikely there are any millionaire or high-income tenants paying less than market rent simply because the landlord is negative gearing.

And finally, a little more sense about the maths, please. Let’s all remember that tax refunds received as a result of negative gearing still represent a portion of the total losses on a property during a financial year. No one is investing in the hope of losing $20,000 per annum on a rental so they can get $10,000 (or less) back. They’re out of pocket by $10,000 on an investment!

Every property investor, big or small, is restricted by income. I can’t speak for the casino-owning Packers of the world, but I can confirm that while many mums and dads would like to own a whole street of rentals, most of us can’t – we couldn’t sustain the out-of-pocket repayments. Making it harder for us to be fairly small fish in the rental sea really doesn’t make sense, or good policy.

The aim of public policy should be to encourage private investment (and wealth creation for all), not whack it mercilessly and stomp on it until it’s shattered, and then wonder why government housing queues are getting longer.

I’m also not sure whether you realise that the perceived health of the property market helps determine that whole Reserve Bank interest rate decision each month? It’s pretty big. Screw with property and watch interest rates move, one way or another. With fairly limited options these days for capital growth, there’s never been a worse time to even think about dropping negative gearing.

Over a million of us would run a mile. 

Melanie Stott is a freelance journalist and regular contributor to The Ryder Report. She also writes for Michael Matusik and works as a TV News producer in Brisbane. Melanie and her husband Andrew own Paradise at the Point, the Gold Coast holiday house featured in 2012’s Big Brother series– and it’s positively geared.

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