The Australian negative gearing tax concession and housing affordability (Part 1)

In Part 1 of 2, Oscar examines the effect of the tax concession on the housing supply.

Housing affordability in Australia

Home ownership is a cornerstone of personal wellbeing.[1] In fact, general and mental health is positively related to both home ownership and housing tenure.[2] Moreover, article 11 of the ICESCR,[3] to which Australia is a signatory, recognises a right to adequate housing. Discouragingly, however, the rate of home ownership in Australia has not increased since 1961 and,[4] in 2013, Australia’s median-house-price-to-income ratio for metropolitan housing was among the world’s highest at 5.8.[5]

In Australia, one particular policy often perceived to have decreased housing affordability substantially is the tax concession conferred upon holders of ‘negatively geared’ property. Is this perception true?

Negative gearing defined

Negative gearing (NG) occurs where an investor borrows funds to purchase an income-bearing asset and incurs a net loss with respect to that asset. A negatively geared rental property, then, is purchased with borrowed funds and yields a net rental income that falls short of the interest on the borrowings: there arises a net loss equal to the difference between the interest payments made and rental income received.[6]

Australia’s negative gearing tax concession

Section 8-1 of Australia’s federal income taxation legislation allows one to deduct losses or expenses incurred in producing assessable income.[7] Hence, this provision is so broad as to allow negatively geared property investors to deduct their net rental losses from their total assessable income.[8]

Evaluating the NG tax concession

Given that Australia is one of the few nations to confer generous tax concessions upon property investors,[9] one might assume that the NG tax concession is a significant cause of reduced housing affordability in Australia. Indeed, certain mass media outlets strive to validate this assumption. For them, the argument of choice is that the NG tax concession promotes NG which increases investor demand for property and, in turn, reduces the supply of purchasable housing.[10] Is the argument empirically supported? To answer this, it is necessary to examine the effects of the NG tax concession on three facets of real housing affordability in Australia: the supply of housing, house prices and income inequality.

Has the NG tax concession decreased the supply of housing?

The NG tax concession certainly has not increased the supply of housing.[11] As at February 2014, 91% of negatively geared property investors purchased existing dwellings rather than constructing new dwellings:[12] undoubtedly, to buy an existing dwelling rather than construct a new one is cheaper, more convenient and allows for investors to receive rental income immediately. Moreover, the rate of population growth has exceeded the rate of housing construction since 2001.[13] Thus it is clear that the NG tax concession has not increased the supply of housing, at least relative to the growing population.

Indeed, Eslake observes that the increased incidence of NG has actually reduced the supply of housing, in reducing rental vacancy rates from approximately 5% to less than 2% over the past 30 years.[14] He contrasts Australia’s reduced rental vacancy rates with the higher rental vacancy rates in other advanced economies, where NG tax concessions are either partially or wholly restricted, and contends that the NG tax concession in Australia has reduced the supply of housing.[15]

Secondly, Eslake has examined changes in the supply of housing between 1985–1987 when Treasurer Paul Keating ‘quarantined’ the NG tax concession by allowing net rental losses to be deducted only from rental income but not from total assessable income.[16] Proponents of the NG tax concession claim, on the premise that rents rose during this period, that this quarantining reduced investor demand for housing, thus reducing the growth of the supply of new housing and ultimately increasing rents. Eslake notes, however, that the premise that rents rose during this period is only partially true.[17]

In fact, rents rose only in Sydney and Perth while rents in all other State capitals either declined or remained steady. Moreover, Eslake points out that rents in Sydney and Perth rose only because rental vacancy rates in those two cities were extraordinarily low prior to the quarantine period: had their rental vacancy rates been higher, their rents would not have risen. Hence, if it were true that the NG tax concession has increased the supply of housing in Australia, its quarantining would have decreased the supply of housing nationwide. In showing the absence of such a result, Eslake concludes that the Australian NG tax concession has not increased the supply of housing relative to the growing population.

Lastly, tenants who rent property owned by negatively geared investors suffer reduced security of tenure because their negatively geared landlords are much more likely to terminate leases than positively geared landlords.[18] Insofar as tenants have reduced security of tenure it appears that the supply of rental properties, or at least the supply of long-term rental properties, is also diminished by the NG tax concession.

Verdict 1/3: supply of housing

The NG tax concession has reduced the supply of purchasable housing.

In Part 2 of 2, Oscar considers the effect of the NG tax concession on two more facets of real housing affordability: house prices and income inequality.

References

[1] Saul Eslake, Australian Housing Policy: 50 Years of Failure (2013).

[2] Jim R Dunn, ‘Housing and Inequalities in Health: A Study of Socioeconomic Dimensions of Housing and Self Reported Health from a Survey of Vancouver Residents’ (2002) 56(9) Journal of Epidemiology and Community Health 671.

[3] International Covenant on Economic, Social and Cultural Rights, opened for signature 16 December 1966, 993 UNTS 3 (entered into force 3 January 1976).

[4] Eslake, above n 1.

[5] Demographia, 10th Annual Demographia International Housing Affordability Survey: 2014, Demographia (2014) .

[6] ATO, Rental Properties (1998).

[7] Income Tax Assessment Act 1997 (Cth).

[8] ATO, Income Tax: Subsection 51(1) – Relevance of Subjective Purpose, Motive or Intention in Determining the Deductibility of Losses and Outgoings, TR 95/33 (1995).

[9] Luci Ellis, Housing and Housing Finance: The View from Australia and Beyond, Reserve Bank of Australia (2006).

[10] Nassim Khadem, ‘Boom Puts Spotlight on Negative Gearing’, The Sydney Morning Herald (Melbourne),  <http://www.smh.com.au/business/federal-budget/boom-puts-spotlight-on-negative-gearing-20140411-36him.html>.

[11] Saul Eslake, ‘Crunch Time for Negative Gearing’ (2011) (4) Fair Share – The Tax Edition.

[12] RBA, Lending Commitments – All Lenders, Reserve Bank of Australia, Statistics Table D6 (2014).

[13] Eslake, above n 1.

[14] Eslake, above n 11.

[15] Ibid.

[16] Eslake, above n 1.

[17] Ibid.

[18] Gavin A Wood and Rachel Ong, ‘When and Why Do Landlords Retain Property Investments?’ (2013) 50(16) Urban Studies 3243.