Government spin can’t hide the harm of negative gearing

by John Daley

Published by The Age, Tuesday 26 April

The debate about negative gearing and capital gains tax needs more facts and context, less spin and anecdote.

The debate will be a hot topic for the looming election campaign, judging by Sunday’s press conference in which Malcolm Turnbull and Scott Morrison jointly announced they would not make changes to these tax concessions in the May budget.

A report released this week by Grattan Institute, Negative gearing and capital gains tax reform, seeks to generate a more informed debate.
The argument goes that current rules for negative gearing and capital gains tax are needed to encourage savings and investment, particularly for people trying to get onto the ladder of home ownership. We are told that the property market relies on people being able to deduct the interest costs from their investments against their labour income. If investors paid tax on any more than half of their capital gain, it is said, they would leave the market in droves.

The arrangements are indeed generous. A person with a high income can negatively gear a property, pay less tax in total than if they hadn’t invested, and still clear a profit.

But it’s not at all clear that such generosity is needed. Other countries with a less generous capital gains tax regime than Australia have plenty of investors in property. And except for New Zealand, all the developed countries we identified have negative gearing arrangements less favourable to investors than Australia.

The primary beneficiaries of Australia’s regime are not struggling would-be first-home buyers. They are wealthy Australians. The top 10 per cent of income earners receive three-quarters of taxable capital gains. And those in the top 10 per cent of income earners (before deducting losses on property) get almost half the tax benefit of negative gearing. People aged 30 to 34, a prime first-home buyer group, are less likely to negatively gear investment properties than people between the ages of 35 and 60.

The costs of this tax regime are large. For every taxpayer that negatively gears, nine others do not, and they pay more tax to subsidise the minority of negatively geared investors. We estimate that the Commonwealth would raise an additional $5 billion a year in tax if investment losses could not be deducted from labour income, and if tax was paid on 75 per cent of capital gains rather than the current 50 per cent.

The additional taxes required to make up this $5 billion a year subtract far more from the economy than is added by the current negative gearing and capital gains tax arrangements. Evidence from around the world shows that tax incentives don’t do much to increase how much people actually save.

However, they do impose other costs on society. They alter where people save. They encourage investment in assets that are expected to have high capital returns, even if their annual returns are lower. In Australia for the last 15 years, that meant residential property. As a result, people have disproportionately invested in property rather than in more productive assets.

The tax arrangements also encourage investors to borrow more than they would otherwise. As a result, almost all of the net additional 700,000 investors in property over the past 15 years are negatively geared. As the Reserve Bank and Murray financial system Inquiry cautioned, the overall effect of these tax concessions is to make property prices more volatile, and make the economy more vulnerable to external shocks.

Finally, our tax regime contributes to falling home ownership rates for all households under the age of 55. The current tax arrangements encourage investors to pay a little more, giving them an advantage at auctions over would-be home-owners.

On Sunday the government tried to defend negative gearing by showing a young family that has borrowed to invest in rental property that will be one day be a gift to their one-year-old daughter. All very nice for baby Addison, but surely it would be better if young people didn’t need to rely on well-off parents to get into the property market.

We are told that any change would lead to a property price crash, rising rents, and less construction of new property. It’s high time these furphies were banished once and for all from around the Parliamentary water-cooler.

Our analysis demonstrates that the tax changes we propose will lead to property prices that are about 2 per cent lower than otherwise. This is much smaller than typical price changes from year to year.

And there is unlikely to be any material change in rents or new construction because new supply is primarily constrained by planning permissions rather than by lack of returns. Studies around the world show that in practice tax changes are primarily reflected in property prices, while impacts on rents are too small to measure.

The facts suggest that current tax arrangements are economically and socially damaging. They are too generous, require increases in other taxes that drag more on the economy, distort investment away from where it would add the most to national prosperity, reduce home ownership, and primarily help high-income earners. Spin and anecdote cannot obscure that it is time for change.