#ESSAdebate - Negative Gearing
Negative gearing occurs when the rental return from a property is less than the interest repayments and other outgoings incurred. Investors are then able to claim the interest payments, as well as some other expenses, as tax deductions. One side of the debate sees this as artificially inflating housing prices, whereas others see it as a natural and beneficial consequence of ordinary taxation policy. The debate gets political quickly, typically pitching younger voters concerned with housing affordability against older Australians concerned about their wealth. Indeed, the Labor and Liberal parties have staunchly opposed views when it comes to negative gearing and housing in general. The Liberals are looking to maintain the status quo, whereas Labor is seeking to wind back negative gearing through only applying it to new housing (with prior investments being grandfathered), as well as increasing the Capital Gains Tax.
In defence of negative gearing – Chris Craig
Negative gearing is claimed to be a tax concession which artificially encourages property investment, however this could not be further from the truth. Negative gearing is an application of a longstanding taxation principle wherein expenses incurred in producing income are tax deductable. For example, a builder is able to deduct the cost of a new tool from their taxable income. Why should investment in property be treated differently? Negative gearing merely allows investors to deduct costs incurred in the course of running an investment property.
There are further theoretical reasons why negative gearing is necessary and preferred. As the Treasury noted in their 2015 Tax Discussion Paper, negative gearing ensures that debt and equity financing are viewed equally by investors. Negative gearing also counters our taxation system’s bias towards owner-occupiers. Owner-occupiers, as opposed to investors, are exempt from paying land or capital gains taxes on their properties. This disincentivises investing in property, diminishes the supply of rental properties, and thus drives up rental prices. By encouraging investing in property, negative gearing serves to somewhat balance these policies out.
The more practical impacts of abolishing negative gearing show just how misguided a policy this would be. Removing negative gearing would cause house prices to fall, with forecasts (which also factor in Labor’s capital gains tax changes) on average predicting a 5% drop. This number is far more impactful than it seems for a few reasons. Firstly, Australian household wealth is mostly tied up in property, which represents 58% of household assets. Any fall in house prices would therefore have an immense impact on Australians’ wealth, causing spending and confidence to plummet. Further, the Australian housing market is already experiencing a dramatic downturn. Abolishing negative gearing would exacerbate these falls, and could lead us to recession. Even with grandfathering, removing negative gearing (and increasing capital gains taxes) would also cost 32,000 jobs and $11.8 billion in building activity, and push the number of Australian households in negative equity to over 1 million (currently there are only 400,000). Abundant negative equity puts the economy in a precarious place, and would cause further reductions in spending, confidence, and lending.
Rents would also increase if negative gearing were removed. Estimating the precise impact is difficult, however, the Henry Tax Review stated that merely reducing some of the benefits of negative gearing would materially increase rental prices. The Review went on to say that complementary policies such as increased rental assistance would be needed in order to counter this effect.
Lastly, it is important to dispel two key myths surrounding negative gearing. Negative gearing does not make Australia have the ‘most generous property tax concessions’ in the world. We need only look to New Zealand, where there is zero capital gains tax, to see this. It is also incorrect to say that negative gearing only benefits the richest Australians. Almost two-thirds of those using negative gearing have a taxable income of under $80,000, and those in the lowest 10% of incomes would be proportionally hit hardest by its abolition. Indeed, fewer than 10% of negative gearers are in the top tax bracket.
Accordingly, we must not view negative gearing as a baby-boomer tax rort, but see it with fresh eyes for what it really is. Negative gearing is the application of an ordinary, uncontroversial tax principle, which keeps Australians’ wealth intact and strengthens the Australian economy. It protects renters, keeps investment financing decisions unbiased, and is nowhere near as regressive or generous as its opponents claim. The result of the 2019 election suggests that this is largely the view of the Australian public.
Policies against negative gearing – Conor Yung
The Australian Labor Party (ALP), are the most active political party opposing negative gearing. Labor’s policy on negative gearing is to abolish it for investors in existing properties. Meaning that, if investors want to write off their investment losses against their personal income, they need to invest in the construction of new properties.
Negative gearing is a part of a tax system that increases demand from wealthy investors. Crucially, it is not negative gearing in itself which is distorting the housing market, but rather negative gearing coupled with a capital gains discount, that makes investment viable, by making tax minimisation viable. Economists remark on how negative gearing has been around since 1922, however, it was the capital gains discount of 50% in 1999, which has led to the house price inflation. This is because investors could trust that their assets would appreciate to a level at which they could pay off a reduced tax burden. Following the instalment of capital gains tax by the Hawke/Keating government, investors would pay tax on all the profits made from the sale of a property, which would be taxed at their personal income tax rate. However, as a result of the capital gains discount, half of the profits from the sale of an investment go untaxed. Investors then use negative gearing to offset the tax on the 50% against the personal tax rate. Consequently, investors have been able to trust that their investments will appreciate in value enough to cover the reduced tax burden. This itself, has led to a self-fulfilling prophecy, in which more investors have gone into the market bidding up the price of properties.
Demand increases = Financial volatility
The reason the current tax arrangements are inflating the housing market is because they artificially create demand without an addition in supply. Investors have been able to leverage a favourable tax arrangement to bid up the prices of properties that would otherwise be in reach of first home buyers. Key members of the Liberal party, such as Treasurer Josh Frydenburg, have vociferously opposed the proposed negative gearing alterations, arguing that Labor is ‘smashing up people’s homes’ and ‘driving up rent’. However, this ignores the evidence that 93% of investment properties have been in established properties, thus, negatively geared properties barely increase supply. Therefore, with current tax arrangement of negative gearing coupled with the capital gains tax discount has lead to demand vastly outstripping supply and consequentially, house price inflation.
The Reserve Bank and the Productivity Commission have both raised concerns about the financial stability of this arrangement, as investment tends to propel economic trends.19 Boom times will rapidly feed investor demand as there is an expectation they will see an appreciation of their asset. Contrastingly, in bust times, demand will shrink as price fallings will lead to selling and low investment. Thus, an imbalanced tax arrangement leads to financial instability, which locks people out of the market. The only major attempt to solve house price inflation, the First Home Buyers Grant, failed this same principle. The First Home Buyers Grant was a cash transfer to first home buyers, designed to allow them to enter the market. However, rather than make it easier, it simply caused more inflation, as it was a demand increase, without any increase in supply. Hence, in order to foster a stable housing market, the government needs to pursue policies that decrease demand without hindering supply, removing tax incentives is the easiest way to do so.
In 1985, the Hawke/Keating government temporarily removed negative gearing on other income streams. This meant that investment losses could be offset against future rental profits, and taxable gains from other rental properties, however, not against one’s personal income. Opposition to negative gearing changes quote the decrease in investment proceeding these changes as evidence for subsequent volatility, if Australia pursues Labor’s reforms. However, whilst some investors did leave the housing market, markets maintained steady rental costs with the exception of Sydney and Perth, of which already had unusually low rental vacancy rates.
Indeed, modelling from economists suggests that proposed changes to negative gearing do not risk a market slump. For example, modelling from the Grattan Institute estimates that Labor’s changes will result in a modest house price decline in the range of 1-2%.
The bottom line
Negative gearing only became a vehicle for tax minimisation following the 50% capital gains tax discount in 1999. Negative gearing creates tax concessions that make it easier to procure investment properties at the expense of first home buyers. By adding demand to the market, investors are able to bid up prices, which forces would-be first home buyers to renting to wealthy investors. Lastly, the so-called ‘Mums and Dads investors’ is a myth. Taxation statistics find that people appear to be of middle incomes only are, precisely because they have negatively geared properties to decrease their taxable income.
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