Negative gearing: Glue in the “House of Cards”?

Negative gearing: Glue in the “House of Cards”?

While it has faded amongst the haze of the US primaries, the Panama papers and more recent tax debates, something remarkable happened on February 13th. Labor Opposition Leader Bill Shorten unveiled sweeping proposed changes to negative gearing and capital gains taxation as part of the party’s 2016 election platform. Upon the party entering Government, Negative gearing would be restricted to new build properties only, and the capital gains discount would be halved. Journalists, economists and rival politicians were stunned: Genuine reform to housing policy appeared to have been forced onto the agenda for the first time in over a decade. But why are these changes so revolutionary? and what is negative gearing anyway?


Negative gearing refers to the process whereby individuals are able to deduct investment losses from their taxable income (including wage income). This is unlike most other countries, where losses from investments can only be deducted from income derived from other investments (for example, a $100,000 loss from the sale of shares could be only be deducted from $500,000 made from selling another investment for a total of $400,000 in taxable income). In the process, the investor reduces their taxable income and therefore the amount of tax paid. This begs the question, why is Australia relatively unique in its stance on investment taxation, and why should the Australian taxpayer subsidise you losing money on your investments?


Intuitively most people would know that the overwhelming majority of negative gearing investors are not losing money on their property investments, with house prices having risen substantially over the past two decades across the country far in excess of wage increases and inflation measures. The losses deducted from a negative gearing investors tax bill are effectively a result of uneven cashflow, the cost of interest incurred from amounts borrowed to buy a property is in excess of rent collected from tenants. When it comes time to sell the property, house prices will hopefully have risen and the investor be able to cash out and make a windfall profit from the capital gain (the ‘gap’ between the buying and selling prices). At this stage, the capital gains discount becomes a key factor in the outcome. Under this policy introduced by the Howard Government in 1999, all capital gains on investments held for longer than twelve months are halved for income taxation purposes. As a result, the maximum rate of taxation on any windfall gain will be 24.5% (half the 45% rate with the 2% Medicare and budget repair levies).


Wait a moment, you might ask, how is it reasonable that investors not only receive a tax break to hold an investment, but also to sell one? Given that wealthier individuals not only have greater resources to take advantage of tax breaks but also receive greater benefit on an individual level, its a remarkably regressive policy in a reasonably progressive taxation system.


The reaction from the Government and civil society to Labor’s proposed changes has been equally remarkable. Within days, Prime Minister Turnbull was stating on the record that “

every home owner in Australia has a lot to fear from Bill Shorten.”, Treasurer Morrison was saying that the policy would “severely [distort] the residential real estate market”. The Housing Industry Association launched a advertising campaign entitled “don’t play with negative gearing”, representing the housing industry as a house of cards.


Few institutions are as central in Australian collective identity as the family home and home ownership, so its little surprise that Federal housing policy has always fraught with challenges. Take the current prime minister, who in 2005 described the two policies under review as a “sheltering tax haven… skewing national investment away from wealth-creating pursuits, towards housing” but who is now supporting the very policies that he attacked. Since the introduction of the capital gains discount in 1999, coupled with a falling interest rate environment, Sydney house prices have skyrocketed from a median of $285,000 in Q3 1999 to $807,000 in Q1 2016. When the GFC threatened to derail the housing market, the Labour government introduced First Home Buyer Grants and the RBA cut interest rates to artificially stimulate demand, allowing prices to remain stable in spite of economic turbulence


While this trend may seem overwhelmingly positive in the eyes of many, it is deeply unequal, as the benefits of house price appreciation stream to home owners and those who have the resources to invest in the property market.


But this brings us back to the essential question, what exactly is negative gearing for? If it is for encouraging investment in new housing construction, why can existing housing or even shares be negatively geared? if it is, as Treasurer Morrison says, the “one chance [middle income people have] to build some wealth”, Why are close to 60% of investment property finance commitments held by those earning top quintile incomes? And when there are so many demands on the tax payer dollar, is wealth creation for ‘Mums and Dads’ really worth $2 billion annually in forgone revenue?


Confusion at the core of the purpose of negative gearing may explain the contradictions seen between the statements of the Government regarding the policy. It will “smash the housing market”, deliver “contradictory shocks” that will reduce the price of existing housing yet increase the price of new housing, remove “all” investors from the housing market (despite only ~2/3 of investors negative gearing) and somehow both drive up and reduce rents.


Thinking through Labor’s policy in simple economic terms, an investor leaving the property market would likely sell to a person who would otherwise be renting, reducing both the number of renters and investors by one – the supply of rental houses in reduced but the rental demand is equally reduced. In such an environment, prices may rise or fall, but these falls cannot be attributed to the change of policy. Investors would instead shift to new housing, increasingly supply to match increasing demand on housing from Australia’s growing population.


Given the deleterious impact of housing unaffordability on the most vulnerable in our society, policies that aim to remove incentives for house prices to rise fulfil an important social good. Labor’s policy proposal has shaken the ‘house of cards’, and business as usual policy for the housing market is no longer an option for our “everything is on the table” Prime Minister.