Sunday, April 19, 2015

The Politics of Negative Gearing (Australian Property)

Debate over the ability for investors to negatively gear property (claim losses from property against other income) in Australia has been fierce of late.

In a recent article Sinclair Davidson (Professor of Institutional Economics at RMIT University) was reported as describing public debate around negative gearing as “a complete load of rubbish” (sadly his comments were no less bin worthy). Rather than tackle the issue with any seriousness he resorted to ad hominem attacks on those making the case against the tax policy, claiming that "ACOSS and other people who don’t actually pay tax themselves don’t understand much about the tax system". He went on to say that other countries (US, NZ, Japan) allow such deductions (so why shouldn't we) and suggested the campaign against negative gearing is just an attempt to raise more revenue.

Jessica Irvine also suggested negative gearing is a budgetary matter (in an article yesterday), calling negative gearing a "loophole" and suggested it's closure would "raise billions".

The reality is that an end to negative gearing for property wouldn't be a huge budgetary boon (as these commentators have suggested). Most advocating for it's removal suggest a 'grandfathered' approach, which means properties already owned by investors aren't affected (until the asset is sold). Even when investors make a purchase (following negative gearing's removal), any losses which would have previously been deducted in the same financial year against other income could be carried forward to claim against future income or profit from the same asset class (property). While it might delay when deductions are made (and some investors may not make a future profit in property meaning it never is), improving the government budget in the short term, it's long term impact would be negligible.

Furthermore, it's likely that over time investors would adjust their expectations and reasons for investing in property. Currently a large number of investors buy for the tax advantages that negative gearing (and other tax breaks) offers (graphic via Digital Finance Analytics):

It's removal would result in a lower number of investors prepared to speculatively purchase at higher prices knowing that (as it stands now) low yields (& resulting losses) are partially offset by a tax deduction against other income at the end of the financial year (or as they go for those investors using an Income Tax Withholding Variation). Over time this would likely result in a normalisation of rent to price ratios so that fewer investment property purchases would be loss making from the outset.

So why support an end or changes to negative gearing if it's impact on the government budget would be minimal?

Some propose that all investment assets should be treated the same when it comes to taxation (losses from shares or business can also be offset against other income in many cases), but not all assets are equal. Like food and water, shelter is one of life's necessities and although one doesn't need to own the land and home they live in to benefit from it's utility, the increasing cost of housing is having an impact on the ability of Australian families to enjoy a lifestyle we've grown accustomed to.

There will never be a day where every household is able to afford to buy (or have an interest in doing so if the flexibility of renting is preferred), but with a historical home ownership rate of 70%, the figures recently coming out suggest that balance is tipping unreasonably in favour of investors.

Being a Senior Fellow at the Institute of Public Affairs, Davidson would probably be an advocate for a free market approach to the property market and affordability problems that arise, but the Australian property market is far from free with government & public institutions involvement in almost every aspect, including where they will allow new construction and approving or rejecting applications, significant fees and taxes added to the cost of building and selling a new home, setting the cost of money to borrow, regulating lender rules, setting the tax policy which makes it attractive, boosting the ability of buyers to purchase using grants and concessions and guaranteeing the financial institutions who would be destined to fail should the property market ever experience a severe bust. The distorted property market that we have today has come from decades of poor policy decisions, any solution will likely need to come from the same place.

Negative gearing is a tax policy that gives investors an unfair advantage in the bid to secure a property. An investor obtaining rent from a property and the ability to deduct any losses made against other income gives them an ability to carry a higher level of debt than they'd be able to otherwise. One of several government based enablers that are driving the demand side of the market to the point we are seeing a speculative investment frenzy in some cities. It's time to wind back these demand driving policies.

Within the next month we can expect to see the outcomes from the long awaited Senate inquiry into affordable housing. After comments from Nick Xenophon last year in an open letter to Prime Minister Tony Abott, that we should consider tweaking negative gearing to encourage affordable new housing (which I read to suggest quarantining negative gearing to newly constructed homes, a reasonable alternative to dumping it altogether) I was hopeful this inquiry might result in some changes. Recent comments from Abbott suggest that he will not consider such changes.

Despite housing affordability being a hot topic at the last federal election, neither of the major parties had any policy specifically directed at tackling it. Though quarantining negative gearing to new builds or removing it completely would only be one part of a solution to tackle the problem, Abbott has made it quite clear that he's not interested in a sensible debate on the matter. Last month Labor released a discussion paper aimed at informing Labor’s Housing Affordability Strategy (to be taken to the next election). I'd expect that with the right mix of policies directed to tackling housing affordability and the right attitude (knocking back ideas before the results of the Senate inquiry into affordable housing as Abbott has done is one way to show you are not taking the national discussion seriously), Labor might just have an edge that could help them secure a win at the next federal election.

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