Published at Inside Story, Thursday 3 March
The intensity of public policy debates can sometimes make it hard to determine the exact moment when the wild horses of argument morph into unicorns. But yesterday, just over a week into a government scare campaign about Labor’s proposed negative gearing changes, the crossover happened. The moment was the release of an “independent” modelling report by BIS Shrapnel, sent only to a handful of journalists, purporting to show that the removal of negative gearing for existing homes would spike rents, destroy housing construction and wipe $19 billion a year off economic growth.
The convoluted logic of the report, its manifestly ridiculous economic predictions and the fact that the consulting firm in question refuses to disclose who commissioned it were not enough to stop the report being the lead story of at least one national newspaper.
The report’s claims must not go unchallenged. But nor should the fact that a report that would flunk any first year economics course has been allowed a serious voice in the public debate.
Here are just two of its outlandish claims. First, the headline grabbing $19 billion GDP figure. The report claims that removing negative gearing for existing (but not new) properties would shrink cumulative GDP by up $190 billion over ten years.
All tax increases drag somewhat on economic growth, but some have less of an economic effect than others. Treasury estimates that the loss of economic activity from every dollar of tax collected ranges from almost nothing, for broad-based land taxes, to 50 cents for company tax and more than 70 cents for residential stamp duties (the most inefficient taxes).
The consultancy’s report suggests that the annual increase in tax collections from the change to negative gearing would be $2.1 billion. The $19 billion hit to GDP would make the loss of economic activity from each additional dollar of tax collected more than $9. That’s right, more than ten times the economic harm of stamp duty, almost universally accepted among economists as the most economically damaging tax. While Treasury hasn’t published estimates of the economic effects of limiting negative gearing, Grattan Institute has previously made the case that it is likely to be one of the least damaging tax changes on offer.
While difficult to divine, the extreme GDP effects threatened in the report seem to be driven from the assumption that the change would shrink new home building by 4 per centa year.
That is implausible. A standard economic model would suggest that reducing a tax concession for investors would reduce their willingness to pay, leading to a one-off decline in land prices (and therefore a drop house prices that we estimate to be between 1 to 2 per cent). Developers with existing banks of land would take a hit – hence their strong campaign against change – but they would maintain their returns on new investments going forward.
By contrast, the report assumes that land prices won’t fall. Instead, residential land would become attractive for industrial, commercial or retail uses. That’s a strange conclusion for a specialist property consulting firm that is paid to know something about zoning restrictions and the higher return on residential development.
Beyond ignoring the lower cost of investment from lower land prices, the report makes a series of unjustified assumptions to reach the 4 per cent figure. It ignores the fact that tax losses would still have a value because they could be written off against future investment income. It assumes that investor demand is extraordinarily sensitive to changes in after-tax returns for property. It also assumes that new housing starts would fall by almost the same proportion as investor demand. In fact, negatively geared investors account for only about a third of property investment. So this assumption would imply that for every negatively geared investor that leaves the market there would be three fewer new home starts.
The second of the more fanciful claims is that restricting negative gearing would lead to rents rising by up to 10 per cent. This assumes that the reduction in the tax concession for investors would be passed on in full through higher rents. Yet there is no basis for assuming that landlords could recoup anywhere near the full loss in tax benefit through increasing rents.
That’s because rents are ultimately determined by the balance between demand and supply for rental housing. In property markets – as in other markets – returns determine asset prices, not the other way around. Rents don’t increase just to ensure that buyers of assets get their money back.
Competition in rental markets would limit material rent rises. Because the negative gearing changes modelled in the report are grandfathered, the vast bulk of landlords wouldn’t pay higher taxes. Nor would new landlords with positive net rental income. And tenants could beat rent rises by threatening to move.
Some people may choose not to invest in property if tax concessions are less generous. This might reduce house prices, but it would have a minimal impact on rents. Every time an investor sold a property, a current renter would buy it, so there would be one less rental property and one less renter, and no change to the balance between supply and demand for rental properties. Indeed, one of the benefits of changes to negative gearing is that lower prices are likely to make housing more accessible for first home buyers.
The report claims that rents would rise because of the fall in new housing supply. But 93 per cent of all investment property lending is for existing dwellings. And as we already discussed, the assumptions in the report massively overstate any impact on new activity.
But the real concern of this episode goes beyond the claims of this nonsense-on-stilts report. The rise of consultancies churning out “independent” reports to advance the causes of vested interests has been well documented. What is alarming is the prominence these reports receive in public debate. No matter how outlandish their claims or how obscure their provenance, the media report them and politicians quote them. The public, confused or frightened by the numbers, forms the view that policy change is simply too risky. That’s a pretty cheap way of buying policy outcomes, especially ones that help special interests but go against the long-term interests of the country.