Negative Gearing Policy Shift: Political Stunt Or Practical Policy Change?

Behind on every major poll, Labor Leader Bill Shorten plans to change negative gearing rules for property purchases and capital gains tax (CGT) exemptions on all assets. Is it a Hail Mary swing for the fences or a fully-costed practical policy that has been fully thought through? Is it about finding genuine solutions to housing affordability or is it yet another stunt to gather political headlines? Let’s find out. 1. Why is negative gearing and CGT in the cross hairs? Let’s face it - the Australian government has a budget problem! Malcolm Turnbull has yet to outline the Government’s approach to fixing the tax system or structural deficits, originally declaring that "nothing is off the table", but more recently backing away from changes to raising the GST to 15% claiming that the case to raise the GST has not been made. My opinion is that raising the GST is a lazy option anyway, failing to address Government largesse and waste, it’s regressive and would not provide enough benefit (after compensation and the costs of administration are taken into account) to make the effort worth the change. Negative gearing refers to a form of financing whereby an investor borrows money to buy an asset (eg. an investment property), but the income generated by that asset is less than the expenses of owning the asset (in the example of an investment property this would include the interest, rates, body corporate fees,maintenance etc). The resulting loss is then offset against other taxable income, including one’s salary. In addition, to negative gearing, the Howard Liberal Government introduced the CGT exemption that effectively halved the rate of tax on capital gains back in 1998 allowing investors to effectively claim 100% of the losses and be taxed on only 50% of the future gains. Bill Shorten, in announcing his negative gearing/CGT policy, in my opinion, has simply tried to move the debate along class lines in a political move he claims will "put the great Australian dream back within reach for the middle and working class”. Mr Shorten went on to explain the motivation of the Labor party was as follows: "We're doing this because 30 years ago, houses cost around 3.2 times average income — today it's 6.5 times average income” Bill Shorten. Housing affordability, or lack thereof, is always an emotional and political issue. What the very simple median house price to wages ratio quoted by Mr Shorten above conveniently does not consider is all the other factors that affect affordability such as interest rates, inflation rates, exchange rates, terms of trade, and a host of other macroeconomic factors. For example in 1986 (30 years ago) interest rates for the average home loan was 15.50% vs around 5.00% today. Mr Shorten continued to play to the emotions of Aussie battlers everywhere by claiming that "Labor will help level the playing field for first home buyers competing with investors and we will put the great Australian dream back within the reach of the working and middle-class Australians who have been priced out of the housing market for too long.” Aussie home loans founder John Symond hit back against the policy commenting that if introduced this policy could actually lead to house price falls on properties owned by investors, affecting the exact middle, and working, class families he is trying to champion. Mr Symond said that “Eighty per cent of residential investors are PAYG, hardworking mums and dads, and this will have an impact on the value of their homes”. Mr Symonds thoughts are echoed by Executive Director of the Property Council in WA, Joe Lenzo, who claimed “About 241,600 people own an investment property in WA including 163,500 (67.7%) who use negative gearing. Most people who buy an investment property are mums and dads who are trying to do the right thing and not be a burden on taxpayers. These aren’t rich people, but they are using property to secure their financial future”. Besides, housing price growth and affordability have far less to do with any taxation treatment, but rather the availability of land and the shortcomings of our planning policies if we want to have that debate! Perhaps another day? 2. What sort of money are we talking about anyway? According to the ATO’s taxation statistics, in 2010-11 there were approximately 1.9 million property investors in Australia, with 1.26 million of these negatively geared. The average income loss for all negatively geared property investors was just under $11,000 p.a, leading to combined losses of approximately $13 billion annually. In fact the exact policy outlined by Mr Shorten this week, was proposed by the THE MCKELL INSTITUTE, back in June 2015, in its report called Switching Gears. Written by Richard Holden, Professor of Economics at UNSW Business School, and an Australian Research Council Future Fellow from 2013-2017, they actually costed the exact changes to negative gearing rehashed this week by Mr Shorten’s Labor opposition. According to Professor Holders 4th Scenario (out of a possible 5 discussed) "Grandfather existing negatively geared properties plus new negative gearing only for new construction… would put the cumulative 10 year budget benefit at $29.3 billion." “These two reforms (changes to Negative Gearing & CGT) that we announce today will save $32.1 billion…” Bill Shorten said, citing analysis from the parliamentary budget office. In trying to create a class divide, Labor policy documents cite NATSEM figures showing the top 20 per cent of income earners ­receive about half of negative gearing benefits and the top 10 per cent receive 70 per cent of CGT discounts. This apparent “unfair” distribution of the benefits of negative gearing belie the fact that the top income earners simply have more disposable income to invest as a direct result of their increased earnings. However, given that tax office statistics for 2012-13 showed that 55 of Australia's highest earners paid no income tax during that year despite earning at least $1million by managing to write their taxable incomes down to below the $18,200 tax-free threshold, there is clearly room to make things more equitable. However, in my opinion, we should still do so without discouraging higher income earners from investing their money to ensure that when they do stop working they have an income level such that they have either no, or low, reliance on a government pension? 3. Hasn’t the abolition of negative gearing been tried before? Yes it has! When negative gearing was temporarily abolished between 1985 and 1987, the impact on rents varied from city to city. Sydney and Perth (where rental vacancy rates were lowest) experienced a surge in rents, whilst the other states were either significantly unaffected or even dropping slightly. Again, the underlying supply-demand imbalance and normal market forces will do more to either drive or depress rents than negative gearing can ever do. 4. Will Mr Shorten's tinkering to negative gearing actually work? Critics of negative gearing state that the tax incentive has done nothing to increase the supply of new housing, leading to better affordability, and this is backed up by ABS data showing that almost 93% of all investment loans today are going towards the purchase of existing dwellings. Screen Shot 2016-02-16 at 2.42.35 PM However, this basic analysis overlooks an incredibly important market driven factor. That is that investment properties are overwhelmingly existing properties because they are located where the demand for renting is highest and housing is least affordable in most cases. For example, inner city suburbs have by far the highest proportion of rental properties; whereas newer residential estates and developing suburbs further from the city centres have the lowest. The abolition of negative gearing on existing dwellings seeks to artificially disconnect the location of the supply of new rental properties from where the demand for what is effectively tax-payer subsidised rental accommodation. Given the affordability constraints of developing new stock in many of these well established suburbs, many of which have period features, or heritage overlays, or restrictive planning guidelines over them, will likely create localised market imbalances (i.e. an under-supply of new dwellings where demand is highest and over-supply where demand is lowest) which in turn will likely result in a number of largely negative outcomes, including:
  • Lower rental affordability (higher rents) in the locales where renters want to rent. Assuming investors were to lose the capacity to negatively gear, they may seek to increase their rental return to offset the loss of the negative gearing tax benefit. In areas where the vacancy rate is high (above 3%), the capacity to increase rents would be limited by market forces as tenants could just choose alternative premises. However, if the vacancy rate is low (<3%) as is the case in most parts of Australia currently, it would be conceivable that rents could rise as tenants may have limited choice but to pay the rent demanded by the landlord to live in their preferred locale.
  • In these cases, where tight vacancy rates support upward prices on rent, it is plausible that you would see a migration of lower income renters from renting private rental properties toward government funded public housing, or worse still homelessness.
  • If the markets are artificially manipulated it may see a potential glut of rental properties accrue in new and developing suburbs where there is limited rental demand, resulting in a depression of housing prices in these suburbs. Given that many of the residents of these properties are low to middle income families, downward pressure on price growth, coupled with rising interest rates in the future, could see an increase in mortgage stress and defaults in these areas.
This highlights the challenges with tax reform in the area of housing as in effect, you would likely end up with a two tiered investment property market with established suburbs significantly outperforming the newer suburbs as a direct result of the Government meddling with an existing tax policy. 5. What happens if private landlords leave the market? This area of policy reform really is a tricky one and highlights the concept of the ‘Butterfly Effect’. That is the phenomenon whereby a small change in the initial condition of a system results in large changes in later conditions. Whilst, the negative gearing changes proposed by Mr Shorten would be “grandfathered” in for existing property investors and as such there is probably only a small risk that property investors would exit the market on mass, it’s worthwhile pausing to consider an unwanted side effect of the policy should investors be diverted away from providing private rental accommodation in the future. However, the perhaps more compelling drop in CGT exemptions from 50% to 25% could change the investment landscape. Data from the report Commonwealth, state and territory funding shares, (2012–13) shows that the states and territories spent more than $4 billion on social housing and homelessness services, with $3.878 billion spent on social housing (i.e. public and community housing), $185 million on homelessness services and $29 million on the National Rental Affordability Scheme (NRAS). The Australian Government spent around $5.4 billion on housing and homelessness services. The largest cost was Commonwealth Rent Assistance (CRA) of $3.6 billion, followed by social housing costs of $1 billion, $407 million for homelessness services, $303 million for remote Indigenous housing and $87 million for NRAS. The cost of CRA is increasing at a rapid rate and is expected to total approximately $4.35 billion in 2014–15. If private landlords were to leave the market, this would likely necessitate an increased spend from the Government (state and federal) to fill the gap. 6. What other alternatives are there? Recently, Peter Martin, Economics Editor for The Age, reported supposed changes being examined by Treasury for a universal cap on income tax deductions that would apply to negative gearing as well as employment-related expenses such as self-education, transport, union fees and work-related clothing. Already implemented in Britain in 2012 this policy would set a limit, or ceiling, to the total amount of expenses able to be claimed by taxpayers. "It means there's an upper limit. If you set the ceiling high enough, 90% of the population could be unaffected while the big claims would be knocked back," said Neil Warren, professor of taxation at the University of NSW. Figures from 2010-11 showed a cap of $50,000 or 25% of income (whichever was the greater) would affect only 0.9% of landlords and only 1.3% of those incurring a rental loss. A lower cap of $12,500 would affect 9% of landlords and 14% of those incurring a loss. Kevin Davis, Research Director of Australian Centre for Financial Studies and Professor of Finance at Melbourne and Monash Universities, Australian Centre for Financial Studies has suggested that quarantining currently deductible interest costs on negative gearing to only that asset is another way to go. Under this model, investors could only claim losses against the income of the asset (as opposed to any income source as exists currently) and investors would be able to carry forward those losses until such time that the investment either generates a profit or is eventually sold. An advantage of this model is that it is not administratively complex, would be fairer for other taxpayers who ultimately pay for the concessions, and might reduce incentives for excessively leveraged investments Conclusions No matter what happens into the future, whether a Labor or a Liberal Government gets up at the next election, there is a need for considered and prudent tax reform to increase Australia’s global competitiveness and fairness. The fact that we are able to have this debate is a start, but I am disappointed that this opportunity will likely be somewhat overshadowed by political wranglings and as often is the case, sound bites will replace any real reform. To read more about negative gearing, check out The Property Mentors FREE ebook The positives and negatives of negative gearing in Australia.

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