From ABC’s Fact Check confirming MB’s own analysis:
As property prices continue to rise across Australian capital cities, in particular Sydney, the debate around how to address housing affordability problems has intensified.
- The claim: Treasurer Joe Hockey says abolishing negative gearing could push up rents, because that’s what happened in the 1980s.
- The verdict: During the period negative gearing was abolished rents notably increased only in Sydney and Perth. Other factors, including high interest rates and the share market boom, were also contributors to rent increases at the time. Mr Hockey’s claim doesn’t stack up.
Sydney house prices have jumped more than 6 per cent since the beginning of the year, increasing pressure on first home buyers.
The Reserve Bank has raised concerns that “ongoing strong speculative demand” from property investors will exacerbate the run-up in housing prices and raise the risk of big price falls.
Negative gearing, a tax deduction for rental property investors, is an area of contention.
But Treasurer Joe Hockey says if negative gearing is abolished, there could be other serious consequences.
“If you abolish negative gearing on investment properties, there’s a strong argument that rents would increase,” Mr Hockey said on the ABC’sQ&A.
Mr Hockey said that in the 1980s, when negative gearing was briefly removed, there was a backlash from investors who increased rents to “replace the lost income” negative gearing had provided.
“The net result was you saw a surge in rents,” he said.
Mr Hockey has made similar claims a number of times in the past two months. On April 28 he said: “If you were to remove negative gearing you would see an increase in rents and I think that hurts lower income Australians who may be renting those homes.”
ABC Fact Check investigates whether abolishing negative gearing in 1985 caused rents to surge.
What is negative gearing?
To “gear” an asset – such as a rental property – is to borrow to buy it.
An asset is “negatively” geared if it loses money.
A rental property is negatively geared if the rent charged does not cover the expenses of the landlord, including interest payments on the loan and other costs such as repairs, land taxes and rates.
The 2009 review of Australia’s tax system led by former Treasury head Ken Henry explained that the term is usually used when the landlord claims a tax deduction for this loss.
“Negative gearing commonly refers to the ability to deduct such a loss against another source of income, such as wages,” the Henry report said.
The Reserve Bank of Australia said in a 2003 paper on housing affordability that this opportunity for minimising tax on other income made “negatively geared investments particularly attractive to individuals facing high marginal tax rates”.
The Australian tax system placed no restrictions on the ability of taxpayers to negatively gear investment properties, the paper said. “There are no limitations on the income of the taxpayer, the size of losses, or the period over which losses can be deducted.”
The benefits for investors
In a March 2015 paper, the Australian Council of Social Service said the incentive for investors to run a rental property at a loss is partly due to this ability to reduce income tax from other sources, and partly due to the rule that when a property is sold, the capital gain is taxed at only half an individual taxpayer’s marginal rate.
ACOSS said that “in most cases, the investors aren’t actually making a loss because the value of the property increases each year”.
These capital gains “are not included in the calculation of tax until the property is sold, yet without them property investments would not be viable,” the paper said.
“It is the combination of taxation of capital gains at half the normal tax rate when the property is sold, and the ability to claim unlimited deductions for losses in the meantime that drives investors to negatively gear.”
Solicitor Jim O’Donnell, in a paper published in the eJournal of Tax Research in 2005, said when the attraction of “deferred and reduced” capital gains tax is added to the ability to offset rental loss against other income, “the net effect of negative gearing is that the investor can come out ahead in economic terms and still reduce their tax liability”.
The broader effects
In 2012-13 approximately 1.26 million people claimed tax-deductible losses on investment properties, according to Australian Taxation Office statistics. These investors claimed over $12 billion in losses through negative gearing in that financial year.
ACOSS said the availability of these tax breaks for investors who can afford to buy rental properties “threatens public revenue and faith in the fairness of our tax system”.
The Henry review said: “The tax advantages from borrowing to invest in a rental property, also relevant for shares, leads to investors taking on too much debt and distorts the rental property market.”
1985: Negative gearing temporarily abolished
In July 1985, the Hawke Labor Government effectively abolished negative gearing for all future rental property investors.
The reform “quarantined any losses made from owning rental properties,” Mr O’Donnell said in his 2005 paper. This meant that rental property losses “could not be used to reduce tax on other sources of assessable income”.
“However, losses could be carried forward to offset against future rental profits and reduce taxable gains made from other rental properties.”
The Hawke Government reinstated full negative gearing in 1987.
Did rents increase from 1985 to 1987?
To get a clear picture of how rents changed between 1985 and 1987, inflation must first be taken be removed.
Inflation is a measure of the increase in the general level of prices in the economy.
If inflation is included in the rental price analysis it is not apparent what change in prices is merely due to inflation.
Subtracting inflation from rental prices changes is termed the “real” rental price.INFOGRAPHIC: This graph shows the changes in real rents in five capital cities between 1985 and 1989. (ABC Fact Check)
Over the period when negative gearing was abolished only Sydney and Perth experienced strong growth in real rental prices.
Real rents in Adelaide and Brisbane fell considerably over the period, whilst Melbourne experienced low, or at times no, real growth in rents.
Economist Saul Eslake, in a personal submission to a 2013 parliamentary inquiry, said that localised rent increases in Sydney and Perth did not support the argument that negative gearing was the cause.
If the abolition of negative gearing had led to a “landlords’ strike”, “then rents should have risen everywhere (since negative gearing had been available everywhere),” Mr Eslake said.
In an August 1987 cabinet submission for the debate on restoring negative gearing, the then treasurer Paul Keating did suggest that the abolition in 1985 had caused investors to leave the rental market, pushing up rents. “The tax reform changes have now been in place for two years, which would appear to be a reasonable period for adjustment to have worked through so that investors may again return to the rental markets,” the submission said.
However, it also said: “With the notable exception of Sydney, conditions in the residential rental property market are not unusually tight. The evidence suggests that local influences, rather than tax measures, dominate in metropolitan rental markets.”
Property markets typically move in a cycle. When vacancy rates are low, competition among prospective renters increases, giving investors greater power to lift the rents they charge.
Over time, increasing rental prices lead to an increase in vacancies. In turn, this reduces pressure on rents.
This graph from a 2003 Reserve Bank paper on housing affordability shows how vacancy rates and growth in rents move in opposite directions.INFOGRAPHIC: This graph shows the relationship between rent increases and the amount of rental properties on the market that are unrented (the vacancy rate). (ABC Fact Check)
During the period when negative gearing was abolished, Sydney and Perth had the lowest vacancy levels of the capital cities.
Sydney’s vacancy rate was 1 per cent and Perth’s was 1.4 per cent.
The 1987 cabinet submission noted: “The market in Perth has been easing after tightness during the America’s Cup period”.
In contrast, rental markets in Melbourne, Adelaide and Brisbane were not at the same stage in the cycle.
Melbourne and Adelaide in particular experienced an extended period of low rental vacancies from 1982 to 1984.
ABS data for this period shows that in response to the tight rental conditions, real rental price growth in 1984 was over 6 per cent in both cities.
In response to rapidly increasing rental prices, vacancies started to increase in Melbourne, Adelaide and Brisbane, and there was a corresponding fall in rental price growth as market conditions became less tight.
But the data shows that vacancy rates were higher in Sydney and Perth in the early 1980s and fell rapidly in the mid 1980s.INFOGRAPHIC: This graph shows the vacancy rate for rental properties across five capital cities, highlighting the period negative gearing was abolished. (ABC Fact Check)
During the period when negative gearing was abolished, Melbourne, Brisbane and Adelaide were recovering from a period of tight rental vacancies and associated high price increases, while Sydney and Perth were entering a period of tighter vacancies.
Some proponents of negative gearing argue that abolishing it reduces the number of investors willing to invest in rental properties as investment is less attractive. It is argued that this reduces the supply of rental properties, and therefore makes markets in all cities tighter.
This did not occur uniformly from 1985 to 1987, with rental vacancies steady in most cities other than Sydney and Perth, and even increasing in Brisbane.
Bigger factors at play
The 2009 Henry review recommended changing the way investments in rental property are taxed to ensure a “more neutral” treatment of rental property investment.
It said if this was not done gradually, it could lead to the supply of rental property being restricted.
“Phasing in the [reform] over time would allow investors to adjust to the new tax settings and reduce the potential for market disruption. In particular, a smooth transition for highly geared investors in rental properties would limit any short-term disruptions in the supply of rental properties,” it said.
While this lends support to the view that removing negative gearing could result in higher rents, it also indicates a way in which the impact could be moderated.
In any case, the review also said other factors had a bigger bearing.
“While these reforms will address the significant distortions the tax system has on the housing market, a range of non-tax policies have a more significant impact on housing supply and affordability,” it said.
It referred to planning and zoning regulations, approvals processes and the allocation of infrastructure.
What else was affecting rents at the time?
During the mid 1980s, interest rates were high and the stock market was booming.
Mr Keating’s cabinet submission from 1987 said: “High interest rates on financial assets and the prospects of capital gains on the stock market have reduced the relative attractiveness of investment in rental housing.”
In a 2013 report, the Housing Industry Association notes that in 1986 and 1987, mortgage interest rates were over 15 per cent, and says “there is a very strong linkage between interest rates and rental price inflation, with the two variables generally moving in tandem”.
It says higher interest rates increase mortgage servicing costs, which makes renting more attractive than buying a home. Therefore consumer demand for rental properties increases, which pushes up rents.
At the same time, higher interest rates increase the cost to investors of holding rental properties. This encourages investors to increase rents to pass on their higher costs.
Between August 1984 and September 1987, the All Ordinaries index rose by 223 per cent. The ACOSS report says this “diverted investment from housing”.
Lower investment in rental properties limits growth in the supply of rental properties in Australian cities. This can cause rapidly increasing rental prices.
The ACOSS report said the Sydney and Perth property markets were already “overheated” when negative gearing was removed and apart from the effects of the normal property cycle on these markets, the “main causes” of a slump in property investment were higher interest rates and the stock market boom.
“After the share market crash of 1987, and the easing of interest rates in its wake, housing investment boomed,” it said.
During the period that negative gearing was abolished real rents notably increased only in Sydney and Perth – where rental vacancies were at extremely low levels.
This is inconsistent with arguments that negative gearing was a significant factor, with negative gearing likely to have a uniform impact on rents in all capital cities.
At the same time, high interest rates and the share market boom of the mid 1980s increased consumer demand for rental properties, encouraged existing investors to pass on high mortgage costs to renting consumers, and discouraged additional investors from investing in the rental property market.
While the rent increases in two cities did coincide with the temporary removal of negative gearing tax deductions, it is unlikely that change had a substantial impact on rents in any major capital city in Australia.
Mr Hockey’s claim doesn’t stack up.