If you believe the hype, negative gearing is either the greatest evil ever unleashed on the Australian property market or the financial saviour of the nation. We now have 2 sides of politics attempting to reduce the whole argument down to a series of sound bites about first home buyers and the tax system.
And as you would expect, we are getting a lot of hot air and little substance from any of them.
The reason why politicians need to have this conversation is that it is much easier to blame a single issue for all of the wrongs in the world, rather than deal with the 2 things this is really about, which are:
- Affordable housing
- Government revenue
What is Negative Gearing and Why are the Current Conversations About It So Shallow?
This is not an economic or financial lesson, so let’s just ensure we agree on what we are talking about. What negative gearing is about is the use of leverage to acquire an income-producing asset. This can be an investment in property, shares or any other asset that qualifies and can be borrowed against. Any shortfall is an allowable deduction against the investor’s taxable income.
In the Australian Financial Review on the 16th of February, Geoff Winestock reported that only 18.3% of those who negatively gear have taxable incomes over $80,000 p.a. which means that the majority of individuals are not claiming these deductions at the highest marginal rate of tax. What he also made clear, however, is that (perhaps unsurprisingly) those with the highest taxable incomes and consequently more disposable income were getting the greatest benefits in tax savings.
But here is a question that is being deliberately ignored, possibly due to the fact that it could be viewed as offensive to otherwise intelligent investors and taxpayers:
Are these people completely stupid?
Because if we believe the doomsayers, they must be. The story they are happily spreading goes as follows:
- “A sane, rational investor fully intends to lose money.” This is a really dumb proposition, as anyone knows that a tax deduction is not the same as getting the money you have expended, invested or lost back. The maximum benefit you obtain is determined by the marginal tax rate you pay. Why would anyone do this without another benefit in mind?
- “Yes”, say the story tellers. “They are looking to make a quick buck and using the tax system to fund it.” Really? Beyond very limited windows of rapid price growth such as in Sydney in the last couple of years, property is a medium-to-long-term investment option, as turning it over fast will rarely recoup the entry and exit costs. Sure, some people will look for this opportunity, but they are definitely not the dominant percentage of investors in residential real estate.
So Let’s Talk About Affordability
We have been told that negative gearing is driving up prices because people are buying for tax deductions or speculative reasons and we have already established that that makes very little sense. So what are the factors that impact affordability?
Economics 101 suggests we start with supply and demand. Every state in Australia has an issue with affordable housing, and in Canberra we know that challenges around land supply have been an overriding factor.
Can you buy a median price house on a median price block? In most jurisdictions, and certainly in Canberra, the answer is generally “no”. And what we need to realise is that these are not the properties investors are seeking to buy anyway, as they tend to focus more on areas that have high employment bases and established infrastructure.
In simple terms, a government that wants to blame a part of the tax system for these issues is abdicating its responsibilities for affordable housing provision and using the nearest convenient excuse rather than one that withstands serious scrutiny.
Costs vs Benefits
The Grattan Institute, a vocal critic of negative gearing, reported in 2015 that more than 1.2 million Australians had claimed $14 billion in net losses in the 2011/12 financial year. Sounds like a lot. But let’s look at what that really means.
A taxpayer earning between $80,000 and $180,000 p.a. pays a marginal tax rate of 39% including the Medicare Levy. Based on these numbers, this will generate a cost to the budget or tax saving of around $4,500 p.a. And that is not free money. The investor who receives this deduction will still have to make capital repairs to the property at some point, they carry risk of vacancy, and if the rental market ever becomes oversupplied their income stream is threatened. Admittedly were any of the current suggestions to be implemented there would be no chance of an oversupply of housing – but let’s ignore that for a moment.
What would happen if this tax deduction for contributing to housing supply was not available?
- A significant number of potential investors would reconsider their decision
- In an undersupplied rental market such as the current one in Canberra, this would bring about an increased shortage which would affect real people, not just the theoretical market our friends on their soapbox are addressing
- Rents would increase – and for anyone trying to find a property right now, just ask them how they would feel about that. University students will find it all but impossible to commence their studies and future homebuyers will have a higher monthly commitment and take a lot longer to save a deposit
Any of the scenarios above leave a supply gap that needs to be filled just to meet existing demand.
ACOSS have suggested that perhaps this could be filled by institutional investors who for some reason would be far more altruistic towards tenants than negatively geared mum and dad investors. Why didn’t anyone else think of that…?
The answer is simple. Again, it makes little sense. They are suggesting centralising housing supply within major companies or institutions such as super funds whose job it is to produce great returns for investors. Does anyone seriously believe that they will be as sensitive as the one-off property investor to an extra week’s vacancy? Not a chance – they will hold their rents for as long as possible to protect their returns and that will decrease affordability on its own.
Maybe the government could help? Apart from the fact that some of our politicians are seeking to create this problem in the first place, do you believe that they will be able to meet the affordable housing need for anything close to the $4,500 tax benefit per property being received under negative gearing? Seems highly unlikely.
New Housing Only?
The less said about a proposal to create 2 classes of property in Australia where one can be negatively geared and the other can’t, the better. This is purely a political statement designed to somehow appease special interest groups with very limited value in the real world.
I can declare self-interest in this option as businesses in our group sell a lot of new properties every year and this would probably be a benefit in the short term for us. But guess what? We would prefer not to take the short-term, easy returns route and would rather look at what is actually best for buyers, tenants, lessors and sellers in the property market in the long term – and this proposal will never provide that outcome.
Where to From Here?
I understand the fact that the property industry can be too strident in defending the status quo. And there are very good arguments to have a close look at the tax system and any unintentional anomalies that have been created.
Even Saul Eslake (who has never been a big fan of property investment or negative gearing) said in February that looking at the discount on capital gains for tax purposes and the treatment of ‘excess interest’ would “achieve the same result, possibly with less political angst”.
Chris Richardson from Deloitte Access Economics also declared negative gearing “not guilty” of influencing the housing price boom. And now BIS Shrapnel have released a report indicating that the misguided proposal to retain negative gearing on new properties only will not only reduce government revenues by $1.65 billion dollars a year but also tip another 70,000 households into rental stress.
What I fervently hope for is that those who have been over-the-top reactive to the Sydney property boom and used it to ignore years of real market data take a chill pill; and instead of looking for simple, sound bite solutions, actually prepare to engage in a real conversation about improving housing opportunities for real Australians.