As Australia’s property prices continue to rise, housing affordability remains a key concern and the contention over negative gearing has never wavered far from the spotlight. Sydney housing prices have risen more than 6% (ABC News, 2016) since the beginning of this year, and long-term trends show above average growth rates.
Negative gearing is a tax rule that allows investors to claim losses experienced by their assets as a tax deduction. In regards to property investment, it is utilized when the cost of investing in a property including loan interest and general maintenance costs exceeds the rental income it produces. Accordingly, investors are entitled to offset this loss against their total income to reap immediate benefits through decreasing tax paid. The strategy creates a positive return for investors if when the asset is sold, the rise in value and subsequent capital gain is greater than the sum of the ongoing losses over the life of the investment.
In addition, if the asset was held for more than 12 months, investors are only subject to half the marginal tax rate on their capital gain. This is called the Capital Gains Tax (CGT) discount and further promotes negative gearing as an effective tax avoidance tool.
Australia is one of the few countries that allow unrestricted use of negative gearing losses to offset income from other sources. Many other countries create limits by only allowing investors to deduct net rental losses from related rental income.
Comparatively, in Australia, there are no limits on the size of the loss, number of negatively geared properties or the deductible income. Our current system favors investors who engage in negative gearing, essentially subsidizing the practice and leaving those who do not at a disadvantage.
Housing affordability and negative gearing
As aforementioned, the housing market has been attracting plenty of media attention for quite some time. Housing prices are currently 6.5 times average income (ABC news, 2016) making it progressively difficult for new homeowners to enter the market. Existing households are also doing it tough with many households suffering ‘housing stress’, signifying they spend more than 30% of their gross income on housing costs. Tenants face a similar situation with 60% of low-income earners who rent property in housing stress (ACOSS, 2015). In an international housing affordability study, Australia was ranked the third most unaffordable major housing market among other OECD countries including Japan and the United States (Cox & Pavletich, 2015).
One factor claimed to have contributed to the deterioration of housing affordability is negative gearing. With tax avoidance in mind, investors have increasingly taken to it as an investment tool. Property investment is particularly attractive, as the housing market is perceived to be a safe investment. This has led to increased property investment causing inflation and speculation of house prices, thus decreasing housing affordability.
Nevertheless, other factors have also contributed to the overheating property market. These include record low interest rates, first homeowners grants and high immigration levels.
It is worth noting that those who typically benefit the most from negative gearing and the CGT discount are high-income earners. This is due to the fact that high-income earners have available capital to engage in negative gearing, but also the higher applicable tax bracket results in the value of the available deduction being larger. Conversely, lower income earners are being crowded out of the property market due to unaffordable prices. Thus, they are not benefitting the rising house prices and increased value of net assets.
Negative gearing, politics and tax reform
In the lead up to this years federal election, negative gearing has been one topic on the agenda as part of a discussion on tax reform. The discussion has centred on a number of tax policy features including GST, personal income tax rates and company tax rates as well negative gearing and the CGT. In 2011, the most recent year for which tax statistics are available, negative gearing and CGT cost the government $7billion. (ACOSS, 2015).
A widespread view, well articulated by the Business Council of Australia (BCA), is that the government needs to focus on constructing a more fair and growth enhancing tax policy. Outlined in their recent report, ‘Tax Directions for a transitioning economy’, the BCA highlight altering negative gearing and CGT rules as a key stepping stone to achieving this. They perceive limiting negative gearing and the CGT discount an effective way to offset other tax cuts that are growth enhancing, such as lowering the company tax rate from 30%. This is particularly relevant as Australia struggles to overhaul its budget deficit. Furthermore, as the existing rules typically favour higher income earners, it also creates a fairer tax system.
Leader of the Labor Party Bill Shorten has announced their 2016 election policy will include restricting negative gearing to first-home buyers. Specifically, Labour proposes that from July 2017 onwards, negative gearing would be limited to newly constructed housing, still allowing investments made before this date to be fully backed. They also propose decreasing the CGT discount from 50% to 25%. This is aimed at tackling the inequality between low and high-income earners in the property market and halting booming house prices in Sydney and Melbourne. Mr Shorten asserts that limiting negative gearing to new dwellings will “level the playing field for first home buyers” (ABC News, 2016).
Contrastingly, the Liberal Party is less inclined to support these significant changes, warning that limiting negative gearing is dangerous for the already slowing economy. Decreased housing investment could result in rising cyclical unemployment, as demand for construction related labour wanes. Instead, they propose a more mild solution; capping the number of negatively geared properties available to investors.
Whilst the Labour Party support a more Robin-Hood-like policy, the conservative Liberals fear the detrimental impacts large restrictions to negative gearing and the CGT could have on Australia’s economy.
Impacts of restricting negative gearing
The assorted options for restricting negative gearing and CGT being considered by the Labor and Liberal parties will undoubtedly have varied impacts on the Australian economy. Whilst Labor’s approach is more stringent, any changes to the existing rules are bound to affect different stakeholders in the owner occupied and rental housing markets.
Labor argues that by narrowing negative gearing to newly built houses, investment into new property is likely to bolstered, perhaps by as much 10% based on the modelling of former Harvard professor, Richard Holden. This is aimed at increasing the housing stock, hopefully cooling the overheated property market, and making houses more affordable for everyday Australians. Furthermore, it is postulated that the measures will create 25,000 new construction jobs, assisting GDP growth.
Their intentions are to bring a more equitable access to housing, however others argue an opposing point of view.
Firstly, a key connection between the primary and secondary market may have been overlooked. By reducing the incentive to invest in the secondary housing market, demand and thus prices for existing houses will slump, as investors can’t reap the same benefits from selling their property in the future and can’t reduce their income tax payable. It is possible this will have a flow on effect into the primary housing market as overall interest in the property market decreases.
For low-income earners and new homeowners the outcome is undefined and depends on how rental property investors react to the changes. As aforementioned, investors could walk away all together from the housing market but it could also mean a complete shift in investment demand to new dwellings, creating fiercer competition and crowding out the market even further.
Renters also face an uncertain outcome. One widely accepted hypothesis, promoted by the Liberal party, is that rental prices will increase. This is due to two reasons with the first being that demand will remain constant in a contracting market as rental investment becomes less profitable. The second is that investors who do decide to retain investment properties may charge higher rental rates in order to maintain a positive return on their assets. These assertions are often supported by the surge in rental prices in 1985, particularly in Perth and Sydney, when under the direction of Bob Hawke, the Australian government abolished negative gearing. Nevertheless, it is queried whether this surge was due to government policy changes or simply other localised factors including cycles in rental vacancy rates and high interest rates.
Undeniably if either party is successful in passing through changes to existing negative gearing and CGT rules, there will be ramifications for the housing market. These outcomes however remain unclear and hotly debated.
Shorten uses NSW ALP conference to unveil negative gearing changes to “level housing playing field”. ABC news. (February 13, 2016) Retrieved from http://www.abc.net.au/news/2016-02-13/bill-shorten-pledges-negative-gearing-changes/7165854
Working out your capital gain. Australian Taxation Office. (2016) Retrieved 13 March 2016, from https://www.ato.gov.au/General/capital-gains-tax/working-out-your-capital-gain-or-loss/working-out-your-capital-gain/
Australian Council of Social Services. (2015). Fuel on the fire: negative gearing, capital gains tax & housing affordability. Retrieved from http://www.acoss.org.au/images/uploads/Fuel_on_the_fire.pdf
Cox, W. & Pavletich, H. (2015). 12th Annual Demographia International Housing Affordability Survey. Retrieved from http://www.demographia.com/dhi.pdf
Realising our full potential: Tax directions for a transitioning economy. Business Council of Australia (March, 2016) Retrieved from http://www.bca.com.au/publications/-realising-our-potential-tax-directions-for-a-transitioning-economy
Negative gearing: What the proposed reforms mean for first-home buyers. (February 15, 2016) Retrieved from http://www.news.com.au/finance/work/leaders/negative-gearing-what-the-proposed-reforms-mean-for-firsthome-buyers/news-story/9b7e3c2c5b68771847000718f44be5e1
Fact check: Did abolishing negative gearing push up rents? ABC news. (March 3, 2016) Retrieved from http://www.abc.net.au/news/2015-05-06/hockey-negative-gearing/6431100
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