EXCLUSIVE: Negative gearing – what needs to change?

Negative gearing remains one of the most contentious issues with Australian taxation policy.

Currently, investors can claim a tax deduction for any shortfall between the rental income earned on an investment property and the interest paid on the loan for that property.

Some argue negative gearing is a rort causing distortions in the housing market, with an over-abundance of investors and speculative investment inflating property prices. Others have criticised negative gearing as an inefficient and inequitable taxation scheme.

However, many others counter such claims by arguing negative gearing investors actually provide affordable housing for renters by keeping rents low and increasing housing stock.

Property Observer took the question to the experts. Negative gearing – what needs to change?

Philip Soos - Economist and post graduate candidate at Deakin University. Co-author of Bubble Economics: Australian Land Speculation 1830-2013.

Current negative gearing policy must be reformed to enhance efficiency in the housing market. It has garnered criticism recently, and justifiably so. Despite the scare stories peddled by the housing lobby, it does not reduce rents or increase supply, as has been amply demonstrated by notable economists Saul Eslake and Leith van Onselen, among others.

"Policymakers can reform negative gearing by making it applicable to only newly-constructed dwellings."

Research by Moody's Analytics estimates negative gearing inflated national housing prices by close to 16% in 2008, falling away to 9% in 2014.

This is the real reason why the housing lobby furiously denounces any recommendations of reform, whether quarantine or removal. Lining the pockets of the FIRE [Finance, Insurance, Real Estate] sector is the overriding goal of current housing policy.

Two-thirds of Australian residential property investors are negatively-geared (1.2 million out of 1.8 million), indicating they are running net income losses in the hope that land prices will rise in the future – speculating, in other words. Given aggregate net rental income was -$8.2 billion in 2012 (2014 real dollars), investors are very much dependent on negative gearing to narrow the income shortfall.

I estimate that forgone tax revenue peaked at $4.2bn in 2008 (in 2014 real dollars), and was $3.9bn in 2012, the latest year Australian Taxation Office stats are available. Realistically, if government were to quarantine or remove negative gearing, investment and prices would fall, meaning the actual savings would be considerably lower, perhaps $2 billion at most.

Policymakers can reform negative gearing by making it applicable to only newly-constructed dwellings, limiting it to one investment and adopting the Ken Henry Review's R14 that only 40% of a rental loss can be recognized. The best reform would be to abolish it completely, not even allowing losses from one property to be offset against the gain for another. This would direct many investors into sensible positive net income positions, reduce reliance on debt and decrease housing prices.

Helen Hodgson - Associate Professor, Department of Taxation, Curtin Law School
, Curtin Business School at Curtin University

The issue with negative gearing is the way it interacts with capital gains tax. Basically, people are getting an ongoing tax deduction and they also pay reduced capital gains tax. And that's where the distortions in our taxation system come from. You can't look at negative gearing without looking at how it interacts with capital gains tax.

If you are going to retain negative gearing, then a higher proportion of the gains need to be taxed. Only taxing 50% of the capital gain is an incentive to negatively gear properties.

"You can't look at negative gearing without looking at how it interacts with capital gains tax."

There are good arguments saying certain categories of housing, where you want to stimulate growth, could be eligible for negative gearing benefits.

So perhaps you could allow negative gearing on new properties, to increase supply, or houses that meet affordable rental criteria.

With the removal of NRAS [the National Rental Affordability Scheme], there's nothing incentivising investors to provide affordable houses. If you were going to target negative gearing, you could target it at that affordable housing sector.

The criteria for NRAS was that the property had to be rented at 20% below market rent. It didn't apply to the purchase price of the house itself, because then you could just buy a really run down hovel and charge cheap rent. We still want to target it at quality homes, where the criteria is pitched against market rent rather than the capital investment in the house. That way, you're less likely to have people coming in and abusing it to buy cheap properties.

In principal, those categories would be able to gain negative gearing benefits, but investors outside those categories would have to defer the loss and claim it against capital gains later down the track – a quarantining measure.

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Terry Ryder – founder of hotspotting.com.au

Nothing needs to change with negative gearing. The system works well in its current form. It assists property investors in providing a pool of available properties for those who choose or need to rent. It also helps people to invest to fund their retirement, something the nation needs people to do.

"There is no substance to claims that negative gearing is somehow responsible for pushing house prices beyond the reach of young Australians."

There are a lot of rubbery figures tossed around in claims about the cost to government of providing negative gearing benefits, but government earns more from the process than it costs.

All levels of government milk the real estate industry for revenue, including capital gains tax, stamp duty, council rates and land tax.

There is no substance to claims that negative gearing is somehow responsible for pushing house prices beyond the reach of young Australians. The market sector most responsible to lifting house prices (keeping in mind that only Sydney among the major cities has had a price boom) is "next time buyers" - i.e. home buyers other than first-home buyers, who are people with the motivation and financial capacity to pay a higher price to secure the property they want.

Dale Boccabella – Associate professor of taxation law in the School of Taxation & Business Law, UNSW Business School, at the University of New South Wales

Negative gearing should initially be addressed from a taxable capacity viewpoint.

There is little to be gained by going back over all the arguments for and against the retention of negative gearing in the income tax system.

"Our income tax already prohibits negative gearing in a number of areas."

They are well known, including the self-serving nature of many of the claims. As far as possible, resolution of the income tax negative gearing issue should be answered from a "pure" and principled income tax position.

But this can only be achieved to a degree because the income tax system is a central feature of Australia's financial landscape and that, like any tax, it can shape behavioural responses (beneficial or damaging).

The starting position is that the income tax, historically and currently, overwhelmingly taxes a taxpayer for a year on their global taxable income. This means that a tax loss on one activity is used against taxable income on another activity. Taxable income is an expression of a taxpayer's taxable capacity. The idea here is that a negative gearing loss represents an expense, just like any other expense, that is related to making income (usually rent, dividends or unit trust distributions), and that it should be permitted.

But, is global taxable income always the best measure of taxable capacity? Our income tax already prohibits negative gearing in a number of areas (e.g. certain small businesses, certain boat ownership "activities", base for various levies, means testing income for access to tax concessions). Further, negative gearing is also prohibited in parts of the social security system and in other public finance rules.

It is the notion of global taxable income (income), as a representation of economic capacity, which is being rejected in these regimes (above) where negative gearing is prohibited. Indeed, what else can the prohibition explanation be?

In regard to negative gearing by many property and share investors, the taxpayer is planning to and does make a loss knowing full well that the loss can be covered by their other income sources. In these circumstances, why should the fact that the taxpayer is planning to make, and can cover the loss, not be recognised in determining the taxpayer's taxable capacity for income tax purposes? Isn't ignoring this reality closing one's eyes to basic facts?

Of course, the notion of taxable capacity does not have a fixed and widely accepted meaning. But where a taxpayer pre-budgets for a measurable loss (within a range) and he/she has other resources to cover the loss, the argument that denying negative gearing to the taxpayer would not be getting to the taxpayer's taxable capacity, does not seem to have much merit.

In the end, the "flexible" nature of taxable capacity may be one reason why the "non-income tax" arguments have got so much traction, and retain traction, in this debate.

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Pete Wargent – Co-founder of AllenWargent property buyers and author

When dwelling prices are in their up-cycle tax law tends to be cited as problematic, with a specific criticism being that so-termed "negative gearing" fails to increase the supply of housing stock in the market. Yet the aggregate of market demand for property clearly is increasing supply, with rolling annual building approvals breaching record highs in August.

"Scrapping tax deductions provides a band aid remedy only."

Over the next two years a stream of stock is due to come online, with real rental growth already set to decline (Perth, Canberra and Darwin look set to win the race to below zero), and requirements for macro-prudential measures or the quarantining of negative gearing rules will fade in concert with easing dwelling price growth.

There's little doubt that tweaking existing tax laws would choke investor demand and market prices would ease.

However, as in the parable The King, the Mice & the Cheese, targeting one distortion in a market merely ignites others - in this case building approvals would evaporate as prices decline, and the 'sticker shock' would put the kybosh on any economic recovery as consumer spending is stymied and dwelling construction dissipates.

Given the above I'd be very surprised if tax legislation was amended, although perhaps if interest rates headed significantly closer to the zero bound the case for restricting deductions prospectively to new dwellings only might gather a head of steam.

Whilst impossible to model accurately, if the failed 1985-7 experiment is a useful benchmark increases in tax receipts would be offset by escalating public housing costs, and I believe that within the course of one solitary property cycle we'd be having the same old discussions about capital city housing affordability due to supply failure.

Housing is obviously not unaffordable across all of Australia. The problem such as it exists is that so few attractive or viable alternatives are presented to those wanting to opt out of the capital city lifestyle.

Using New South Wales as an example, the state population has increased by close to a nontrivial 400,000 over the past four years alone, yet outside Greater Sydney the remainder of the state has created employment growth equalling a grand total of... negative 16,000 jobs.

NSW population growth is now accelerating as the tide of interstate migration now shifts away from the mining states, yet it's plainly unrealistic to expect folk to flock to the regions without adequate business investment or infrastructure, since there are actually fewer regional jobs in the state today than there were back in 2010.

Scrapping tax deductions provides a band aid remedy only. Clinging to the notion that we can house 8 or 9 million people affordably within a contained centric space is folly, and ultimately doomed to fail. NSW does not stand for "Newcastle, Sydney, Wollongong", but until we collectively accept that, expect more of the same.

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Catherine Cashmore - independent market analyst

Of all the policies employed by the government to exacerbate Australia’s housing affordability crisis – our inequitable tax system, which includes negative gearing is top of the list.

Negative gearing has reduced Australia’s housing supply.  Over 92% of investors chase the capital gains associated with second hand dwellings rather than increase the stock of housing through investment into new supply. We replace properties for sale, with properties for rent.

"Negative gearing merely scratches the surface of Australia’s inequitable tax system."

Negative gearing has pushed up the price of housing and widened the gap between price and yield. High and rising house prices naturally put upward pressure on rents and assist in keeping first homebuyers locked out the market.

Negative gearing has turned us into a nation of speculators. Today, the investor share of the market is close to 50%. Investor finance commitments are rising at their fastest pace since 2007. 65% of loans to investors are on interest only terms and an estimated 95% of all bank lending is being channeled into real estate – mostly residential.

Negative gearing costs the government billions in lost tax revenue each year. Around 1.25 million taxpayers (approximately 13% of the total) now have at least one negatively geared property.



Negative gearing employs one rule for the landowner and another rule for the worker. Investors that negatively gear can deduct non-work-related property losses against wages and salaries.They can lower their taxable income as much as they wish by simply by buying enough negatively geared dwellings. The wage earner has no such advantage – why work when you can speculate?

Negative gearing favours the wealthy rewarding high-income earners handsomely. Notwithstanding, the property lobby use artificially reduced taxable incomes to falsely claim that most investors are “mum and dad” average income earners.

Negative gearing merely scratches the surface of Australia’s inequitable tax system. 

Investor tax incentives and their effect on house and land values have been repeatedly clarified by independent tax reviews, as well as previous Senate Inquiries into housing affordability.

The first inquiry conducted by the Productivity Commission in 2004, determined that prices had surpassed levels explicable by demographic factors and supply constraints alone. They stressed that a large surge in demand had rather been “predicated on unrealistic expectations (in a 'supportive' tax environment) of on going capital gains”.

The second inquiry overseen by a Select Senate Committee in 2008, found that the average house price in capital cities had climbed to over seven years of average earnings and once again, they identified inequitable disparities in the overall fairness of the tax system, that had lead to “speculative investment on second and third properties.”

Australia's Future Tax System review conducted in May 2010 stated that tax benefits and exemptions had been capitalised into higher land values, encouraging investors to chase ‘large’ capital gains over rental income and landowners to withhold supply.

The Future Tax System review recommended allowing only 40% of interest (and other expenses) associated with investments as a deduction.

This would reduce the amount investors are able to claim against negatively geared dwellings and provide a good starting point for phasing out the policy altogether.

Negative gearing as well as stamp duties (which are a volatile source of revenue, dependent on the volume of housing transfers in addition to the transacted price), should be replaced by a broad-based SLT (state land tax) – as I recommended here.

Under this scenario, the upfront cost of land would fall, the higher tax base would blunt potential capital gains from speculation, and housing supply would naturally increase as land would need to generate an income.

An enhanced land tax would also provide a steady source of revenue for state government giving them greater control over public finances for the provision of essential infrastructure.

Moreover, study after study demonstrates, that basing a system on the collection of resource rents and monopoly profits, for the direct application of facilitating local and community services, can reduce the tax liability on most households whilst also maintaining complete revenue neutrality.

Unfortunately, 95% of our federal MPs own investment properties. Collectively, the are in possession of an estimated $300 million personal portfolio of residential dwellings.

It is therefore unsurprising that all recommendations from previous Senate Inquiries for meaningful and equitable tax reform have been studiously ignored.