Why it’s time to quarantine negative gearing

ScreenHunter_1907 Apr. 02 15.16

Cross-posted from The Conversation

Abolishing the sacred cow of negative gearing – where losses can be used as a deduction against other income – is considered by governments of all persuasions as electorally unpalatable.

But this part of the income tax system is one of the few areas left which confers this highly favourable treatment. In many other important areas of our public finance and income tax system, negative gearing is effectively abolished in favour of quarantining of losses.

Negative gearing is allowed on passive rental property and share investments and for “large” businesses. Both the pros and cons of negative gearing are well-known. Its most immediate advantage is allowing taxpayers to use a loss on one investment as a deduction against a profitable investment, or other source of income. But it is accepted that it undermines the progressive nature of the income tax, does little to increase housing supply stock and is a significant cost to government revenue.

In contrast to negative gearing, quarantining is where the loss on an investment cannot be used in the year it is made, but can be used in future years, against profits from the same investment from which the loss arose. Usually, but not always, if the investment is sold while there are quarantined losses, these can be used to reduce the taxable profit on exiting the investment.

In our tax system, quarantining is used when determining whether a taxpayer is liable to pay the Medicare levy surcharge; for loan repayments under the higher education loan program (HELP); and assessment of income under the child support regime, particularly Family Tax Benefit Part A and B.

Quarantining also applies when the tax office is assessing means-tested concessions such as the dependent (invalid and carer) tax offset, or senior and pensioner tax offsets.

Small businesses that make a tax loss in a non-corporate form are not permitted to use that loss against other profits (so-called non-commercial loss rules). While these measures are in part a response to the ridiculous hobby tax loss claims of the past, these rules apply quarantining to genuine small businesses, including those in the start-up phase. Quarantining also applies to certain boating activities.

In the social security system, quarantining applies where a particular benefit is means tested, such as Seniors Health Care Card, or the parental income test for dependant youth allowance. Like the income tax though, quarantining is not universally applied under this legislation (for example, it does not apply to the income test for aged pensioners). Also, the current paid parental leave scheme also uses quarantining in its relevant income measurement.

So one can see that quarantining applies in numerous areas of our public finance system. The starting point for debate should focus on economic capacity. By allowing negative gearing, the loss is being treated as a genuine signification of reduced economic capacity to either contribute income tax (or other contribution), or to receive welfare assistance. On the other hand, if quarantining applies, the loss is not regarded as signification of reduced economic capacity to either contribute tax or to receive welfare assistance.

Unfortunately, there are credible arguments both ways. And the fact that countries around the world do not take a uniform approach to the issue under their respective income tax systems supports this.

However, our public finance framework ought to be internally consistent so that similar things are treated in a similar manner, unless there is a sound explanation for differential treatment. This should be the case within the social security and income tax system, as well as across both, as the social security system is the mirror of the income tax system, or a negative income tax.

Both systems have economic capacity at their foundation. Those with sufficient economic capacity make an income tax contribution, and those who lack it receive payments (and other non-money benefits) for economic support. Given the shared foundation of the income tax and social security systems, or that they are really one system, it is hard to see why a different measure of economic capacity should be used within each system or across systems.

Another lesser dimension is that tolerating negative gearing in parts of the income tax and social security systems, but not tolerating it in others parts of those systems, adds complexity. Differential treatment of the same thing necessarily adds to administration and compliance costs.

In the end, there is a real argument that negative gearing should either be restored in the areas where it is currently prohibited, or should be scrapped across the board.

Given where the debate is now, I doubt anyone will seriously argue the former. That tends to leave movement towards the latter, because no one would seriously argue that the current differential treatment is a principled position with credibility.

 

Article by Dale Boccabella, Associate Professor of Taxation Law, Australian School of Business at University of New South Wales

18 Responses to “ “Why it’s time to quarantine negative gearing”

  1. moderate mouse says:

    I don’t buy the argument that scrapping NG on property is politically impossible. People who make this statement automatically assume that it needs to be abolished retrospectively. Yes, that would be politically impossible. But what if Quicksilver Joe were to announce in the upcoming budget that it would no longer apply from 1 July 2014? Who would blame him for taking such a responsible step? The key would be containing any rush to purchase between the announcement and the implimentation.

    Existing investment properties could also be subject to a ‘phase down’ so as to ensure the policy was equitable.

    • Yes, much of the political pain can be avoided by grandfathering. But if housing affordability is the aim, I would suggest two modifications.

      First, allow full negative gearing for future purchases of NEW homes, but not for future purchases of established homes. That would stimulate construction.

      Second, allow the grandfathering only if the home is actually rented, not if it is merely “available” for rent. As jobseekers who reject job offers lose the dole, landlords who reject rent offers should lose their tax deductions.

      • Frederic Bastiat says:

        They will do what Gavin suggests above. Both modifications actually seek to achieve the goal of the policy, and also claw back a fair chunk of revenue for Gov.

        In relation to the second point, I have seen first hand how NG can deter a landlord from lowering the price of their IP to meet the market.

        In Canberra, there are tons of houses / apartments unrented for months…and I can only assume that in the demented mind of aspiring property tycoons, this is ok because the money they are loding hand over foot can be deducted from their other income etc…

        So here, the policy is screwing over everyone!

        1) Government forgoes revenue due to tax deductions
        2) Renters dont get cheaper rents
        3) Landlords, motivated by economic ignorance and desire to minismise their tax, lose out due to forgone income.

        Talk about a bonehead policy!

      • Andy! says:

        Sounds good to me.

        Also, the FIRB will be able to assist with excellent compliance verification of new vs existing.

      • md says:

        @ Gavin “But if housing affordability is the aim, I would suggest two modifications.”

        You’re making a big assumption if you think that housing affordability is the aim, and I would argue that housing affordability is NOT the aim. For housing to be affordable, it would mean popping the bubble and letting prices fall, and no government wants blood on their hands like that. They would pay any price to keep the bubble going as it is.

        @moderate mouse, “Who would blame him for taking such a responsible step?”

        Plenty would. Anyone with a property, and these days, it would have to be well over two thirds, as many renters also own property that they are renting out.

        Personally, I would love to see negative gearing scrapped. It is a major contributor of the housing bubble, and I would be very happy to prick the bubble. But I am realistic to know that no politician is wanting what I want. And, unfortunately, they do what they want, not what I want.

  2. Schadenfreude says:

    Given all the talk in the papers today of tax hikes to paper over the widening budget chasm, they would be dead men walking if they leave NG off the chopping block.

  3. Frederic Bastiat says:

    Saying that negative gearing is a sacred cow that cannot be touched is just lasy journalism and typical of the tripe Fairfax spew out.

    Why would NG be so awful to abolish, but then people talk about raiding income tax rates and GST etc…

    Why would a broad tax increase affecting everyone be more politically palatable than ending a rort that helps the wealthiest the most.

    Its like the housing shortage myth…people say is over and over until it becomes assumed.

    • Hixtar says:

      indeed. I don’t even think that many people understand what NG is to be honest and I certainly don’t know many under 40′s who own investment properties.

      The only reason that it is ‘politically unpalatable’ is because of vocal lobbying from the grey rent-seekers.

      • footsore says:

        “I certainly don’t know many under 40′s who own investment properties.”

        I do. There are three mindsets that I’ve come across.

        1) The bullet proof. They believe nothing will ever go wrong with this.

        2) The sensible road to riches. Young, looking to the future, see it as an investment and want to hop on the property ladder. This is the investment that they believe works best. Not sure if they are hedging. Often started while they were living at home.

        3) The balls to the wall. Scared shit-less. They are in and they can’t talk themselves into getting out. So far it has worked and they know that it might go pear shaped but they aren’t pulling out yet. They are on a bender of hope and dreams.

        It isn’t my cup of chai but best of luck to them.

      • my time says:

        “I certainly don’t know many under 40′s who own investment properties.”

        Really?

        My ex daughter-in-law owned her first investment property at the age of 21. After marrying my son, they owned three investment properties. She was 32 when she and my son broke up.

        My youngest daughter owned two investment properties by the time she was 29, which she sold when she married.

        A young chap (30ish) I worked with owns 4 investment properties with his wife, planning to buy more.

        Had a chat to a 21 yo girl working at a nursery not so long ago and she told me that she owned one investment property and was saving for a deposit to buy another one.

    • The Claw says:

      Its like the housing shortage myth…people say it over and over until it becomes assumed.

      The shortage myth is the myth that “there is no shortage of housing”. Shortage-deniers repeat this nonsense even after the nature and severity of the shortages are explained to them.

      Perhaps the shortage-deniers suffer from “first conclusion bias”. I suspect that many do.

      • Frederic Bastiat says:

        I have never once had it explained to me how you can define a ‘shortage of housing’.

        With so many variables (they key one being housing formation), I just dont understand the value in declaring ‘Australia has a housing shortage’ and what exactly that means.

        I see its value in creating a justification for our bubble, and spruiking the need to “Buy Now Or Miss Out Forever!”…but lets just focus on supply constraints and leave the overall demand and supply question to more nuansed arguements

  4. Rusty Penny says:

    Not yet.

    It needs to drag the country into deep economic depression before we change it.

    The losers in all this have been distressed for a decade, the “winners” need to lose their shirts and be impoverished for the remainder of their lives so they can feel some complimentary pain.

    For us to calmly navigate this back to equilibrium with the mildest form of pain spread out means those that suffered in the past decade did so in vain.

    The actions of this bubble have been cruel, very cruel, to a small (but increasing) group of disadvantaged, whose crime was to be born in the last 20 or so years. It cannot be tolerable that a group of ‘winners’ arise out of such actions.

    • footsore says:

      +1

      The hangover needs to be as big as the party for lessons to be learnt.

      I also don’t mind Keen’s modern debt jubilee. QE from the bottom up to clear some debt. + the savers get more gold for their pots. If this was done at the same time as Gavin’s suggestions I could live with their implementation.

  5. aj. says:

    This is an overly complicated take on NG IMHO.

    The reality is that negative gearing in property is not about earning income it is about speculating on assets. The ATO and the courts have just let a form over substance position run a bit too long. In other words we know the income argument is a dud but we just sort of collectively agree not to be honest.

    The CGT regime covers this perfectly well by quarantining losses (including interest expense) to the gain. We just need to legally acknowledge that if you are losing money due to gearing (both shares and property) then you are looking to profit from asset values and so the CGT regime captures you until positively geared.

  6. simon89 says:

    Abolish it, NG distorts the economy where by giving incentives to out bid your fellow australian to invest in an entirely unproductive assets.

    All forms of investment be is long term deposits, business, shares etc should all be on the same playing field.

    We need australian to think productive as we edge ever closer to the cliff. And for that reason alone should be enough to abolish NG and the distortion it breeds.

  7. my time says:

    I have no real issues with abolishing negative gearing. It will not affect me as my 4 investment properties are positively geared.

    Furthermore, I have no intention or financial urgency to sell my properties, so a temporary reduction in housing values will not affect me either. In fact, it may provide opportunities to add to my property portfolio.

    Will removing negative gearing make buying a house more affordable? People who prefer to rent than buy, will continue to prefer to rent. A small percentage of people may be in a better position of qualifying for a loan, but for the majority of people who do not qualify now, their situation will not change.

    With fewer rental properties available, rents will be pushed up – something we saw a few years ago when prospective tenants were competing at “rental auctions”.