The negative gearing myth of 1985: ACOSS

The negative gearing myth of 1985: ACOSS
The negative gearing myth of 1985: ACOSS

GUEST OBSERVATION

A quarantining approach was adopted by the Hawke government in 1985 when it effectively abolished negative gearing for rental property investments.

For two years after the announcement of the policy, expenses related to rental property investments could not be claimed against income from other sources such as wages. In return for this restriction on deductions, a depreciation allowance was introduced to encourage investment in new rental housing. Existing investments were not affected.

A mythology has grown around the impact of this policy on rental property investment in the late 1980s. It is claimed that the ‘abolition’ of negative gearing directly led to a rental housing investment ‘strike’ and that this was the reason the policy was reversed. In fact, a major reason for the policy reversal was political: property lobbyists threatened to campaign against the then New South Wales state government in a forthcoming election.

It is possible that this campaign convinced some property investors in Sydney that it was no longer worthwhile investing in housing – a self-fulfilling prophecy.

In reality, the housing investment ‘slump’ was restricted to Sydney and Perth, two property markets that were already ‘over-heated’ at the time that negative gearing was restricted. Nationally, investment in rental property continued to increase with the total value of lending to rental property investors rising by 42% over the period that negative arrangements stopped.

The negative gearing myth of 1985: ACOSS

Source: Eslake (2014), “Submission to Senate Economics Committee Affordable Housing inquiry Note: Annual increase in median rents. Shaded area was the period during which negative gearing was not available.

Apart from the effects of the ‘normal’ housing cycle in markets that were overheated, the main causes of the property investment slump in Sydney and Perth were higher interest rates (partly designed to prevent a housing investment ‘bubble’) and the share-market boom of the mid 2000s (which diverted investment from housing).35 After the share-market crash of 1987, and the easing of interest rates in its wake, housing investment boomed.

The ‘restoration’ of negative gearing is likely to have added froth to this speculative boom which inflated house prices and triggered a steep rise in interest rates, which led in turn to the worst recession since the 1930s.

Improving on past policies In retrospect, the main weaknesses of the 1986 ‘quarantining’ policy were that it was introduced at a time when the housing market was about to deflate of its own accord, and that only rental property investment was targeted (when ‘negative gearing’ strategies also apply to investment in other assets yielding capital gains such as shares and agricultural investments).

Otherwise, it was a sensible policy response to a serious flaw in the tax system that distorts the operation of housing and other investment markets. Restricting deductions for negatively geared investments to income from the same asset or class of assets is a more comprehensive solution to the problem than other options considered in the past such as limiting ‘negative gearing’ to investment in the construction of new housing. While these proposals would redirect investment to new housing and ease inflation in home prices, they would not remove the structural flaw in the tax treatment of different investments: the bias in favour of borrowing to invest in assets yielding capital gains, including rental property, shares and agricultural schemes.

There is also a strong case for tackling this problem directly by reducing the inequitable and investment-distorting 50% discount for capital gains. This would best be done as part of a wider realignment of tax rates for different investments - including a reduction in tax rates on rental income as the ‘Henry Report proposes. This could be done in conjunction with ‘quarantining’ rules to remove the ‘timing advantage’ discussed above. These measures should be introduced in conjunction with more efficient tax incentives for investment in new housing, especially affordable housing.

The National Rental Affordability Scheme (NRAS), which provides tax credits for such investment, is being wound down before its impact on affordable housing investment can be properly assessed. This is a mistake. Special emphasis should be placed on incentives for long-term institutional investment in housing.

This policy package would be ‘pro’ not ‘anti’ housing investment. Investment would be redirected from where it is harming housing affordability towards where it is most needed: the construction of new affordable dwellings.

At the state level, the replacement of stamp duties on housing purchases with a broadly based Land Tax (as advocated by the Henry Report) and reforms to Land Tax on rental properties to encourage investment in multiple properties, should be considered. Policies that strengthen housing supply, including direct public investment in social and community housing and reform of planning laws should also be pursued.

These tax and housing reforms would improve housing affordability for tenants on low incomes, ease barriers to first home ownership, and improve the fairness of the tax system as well as the efficiency of investment. It would be good for people struggling to find decent and affordable housing and good for the economy as well.

This is an exerpt from the Australian Council of Social Service (ACOSS) report, ‘Fuel on the fire: Negative gearing, Capital Gains Tax and housing affordability. Read the full report here.

Peter Davidson is senior advisor with ACOSS.

Ro Evans is policy officer with ACOSS.

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Negative gearing

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