With the federal election well underway, there’s plenty of political debate about negative gearing – whether it should stay or go, whether it should be restricted to new property, and whether the capital gains tax concession associated with negatively geared properties should be reduced.
So, what exactly is negative gearing? Is it a form of tax avoidance or really just a perk for the wealthy?
What is negative gearing?
Negative gearing is a practice whereby an investor borrows money to buy an income-producing asset or a rental property. He or she expects that the gross rental income from the investment will not, in the short term at least, cover the expenses of owning, managing and maintaining the property. In other words, there will be a loss. The Australian taxation system allows investors to offset this loss against their taxable wage or salary to provide tax savings.
Who really uses negative gearing?
Negative gearing presents one of the accessible opportunities for low to middle-income earners to build wealth for the future, instead of relying entirely upon government. Nearly 1.2 million Australians negatively gear their investment properties and 78 per cent are earning less than $80,000 per year; these are the teachers, policemen and nurses you might have heard about in the media. While it’s true people earning over $100,000 per year also benefit from negative gearing, they represent just 22 per cent.
The primary motivation for most people to negatively gear an investment property is often the fear they won’t be able to accumulate enough money in super to provide a comfortable living in retirement. They hope to enjoy a capital gain, as well as a 50 per cent discount on capital gains tax, when the time comes to sell. These investors provide a supply of rental properties, which helps keep rents affordable, reduce pressure on government budgets to provide public housing, and are effectively saving for their future.
What are the impacts of negative gearing?
It has been argued that restricting negative gearing to newly constructed property, as opposed to all existing property, would save the budget some $32 billion over a decade. Arguments have been made that investors make up 50 per cent of the marketplace, are bidding up prices, and making it more difficult for first home buyers to buy a property. It has also been suggested that negative gearing is a form of tax avoidance and isn’t standard business practice.
In reality, investors have generally represented closer to one third of buyers in the marketplace at any given time and constraints on the supply of land for construction of new property have the greatest impact on property prices. The most likely solution to affordability involves a combination of increasing the supply of land, by solving the problems of poor coordination between the three levels of Government (Federal, State and Local), and reform of the planning process.
While it is reasonable to review the fairness of the current negative gearing/capital gains tax arrangements, the Reserve Bank has indicated it would rather change capital gains tax arrangements than negative gearing because the right to deduct the legitimate expenses incurred when earning income is an important, long-standing principal of Australia’s taxation system.
Who would be affected if restrictions were introduced?
BIS Shrapnel estimates that limiting negative gearing will remove $19 billion from the economy in the first year. The general consensus on both sides of politics is that property prices will fall, but it’s impossible to know by how much. Estimates vary from 2 to 10 per cent. That would certainly affect the 67% of people who currently own homes and the 18 million Australians who have a stake in property through their superannuation. Obviously if the value of super falls, that would affect the income of retirees as well.
Negative gearing has been said to exclude younger people from the housing market
However, it’s important to keep first homebuyers in mind, particularly as it’s not unreasonable to assume that they would be the beneficiaries of falling prices and improved affordability. The primary barrier to home ownership is the 20% deposit and stamp duties, which even if prices drop by 10% won’t make much difference to this problem. It may interest you to know that the percentage of average take home pay today on an average mortgage in NSW is 31%. For Baby Boomers, who paid 18% interest, the figure was 47% (Source: finder.com.au).
So what about tenants? There’s a great deal of conjecture around this point but if existing investors sell their rental properties or fewer new rental properties are bought, the supply of available rental property will tighten, pushing up rents. Recent surveys suggest between 30% and 79% of landlords will sell their investment properties if restrictions are applied. Interestingly, March quarter CPI figures reveal that existing levels of investor activity have delivered the lowest increase in rents since 1995. In fact, since investor activity began accelerating in 2013, the rate at which rents have been increasing has slowed.
Then, if you’re a landlord, you might be tempted to dismiss the political battle because you’ll still be able to negative gear your property – the proposed changes will only affect people who buy after July 1 next year. But economists say that if the planned changes to negative gearing go ahead, property prices will fall and there will more Government revenue lost than saved. This would push up unemployment, which would have further economic impacts.
Didn’t the RBA say winding back negative gearing ‘might be a good thing’?
The internal Reserve Bank memo that said winding back negative gearing ‘might be a good thing for financial stability’ is deserving of closer inspection. The document was two years old, heavily redacted, and didn’t indicate the impact of a change on the tax system, the housing market, or the overall economy. It’s probably best to view the document in its context and accept restricting negative gearing might make the economy more stable, but ask at what cost to the rest of the economy. Arguably, stability has been dealt with through the tightening of lending requirements on investor loans since late 2015.
What about the class warfare element of the debate?
Those seeking change arguing that the wealthy get the largest share of the total benefits of negative gearing, yet three out of four people who negatively gear earn less than $80,000 per annum. The Australian’s Michael Potter made a good point when he wrote “almost all tax provisions provide a greater dollar benefit to the rich, including the GST exemptions for food, education and health. The GST exemption for food provides a benefit to the top 10% of $631 per year and a benefit to the poorest 10% of $365. Yet no one is using this data to argue for the abolition of the GST exemption for food, because measuring dollar benefits to different income groups is the wrong approach.”
He went on to argue that if applying the same approach to negative gearing, the largest percentage of benefits actually go to the lowest decile of income earners in the tax system.
However you look at negative gearing, the economy is fragile right now, as evidenced by the RBA’s most recent cut to official interest rates, so it would be prudent to examine the impacts of change on the entire economy very carefully. Housing affordability presents a complex challenge with many facets for Australia’s politicians to consider and balance. Whatever your view, you can expect to be hearing a lot more about negative gearing in the lead up to the election.
Written by Stewart Bunn