Saul Eslake is on fire. Earlier this month, Mr Eslake wrote a wonderful article in Fairfax lambasting the first home owners’ grant and other demand-side measures employed in vain by Australia’s governments to make homes more affordable:
Governments have thus been providing cash handouts to first-time home buyers for almost half a century. Yet, strikingly, the home ownership rate has never been higher than the 72 per cent recorded at the time of the 1961 census, three years before the first of these schemes began. At every census since then, it has fluctuated between a low of 68 per cent (in 1976) and 72 per cent (in 1971). At the past two censuses (in 2001 and 2006), it stood at 70 per cent.
Indeed, the apparent stability of the overall home ownership rate conceals a substantial decline in home ownership rates among every age group below 50…
And it’s pretty obvious why. Cash grants and other forms of help to first-time home buyers have served simply to exacerbate the imbalance between the underlying demand for housing and the supply of it…
Cash handouts for first home buyers have simply added to upward pressure on housing prices, enriching vendors (and making those who already have housing feel richer) while doing precisely nothing to help young people into home ownership…
Policies which have, in effect, added only to the demand for housing (or, more strictly, increased the amount which people can afford to pay for housing), have conspicuously failed.
Why, then, have governments persisted with policies that have so miserably failed to meet their ostensible goals? The answer is, surely, that since about 70 per cent of Australians live in homes that they (or members of their immediate family) already own, policies that make them feel richer are much more popular than policies that might allow the small minority of Australians who don’t own their own home, but would like to, to join them.
If governments really wanted to do something about housing affordability, they would abolish cash grants to first home buyers, and ”quarantine” tax deductions for interest paid by landlords to the value of the rent received in any given financial year (with any excess carried forward against the capital gains tax liability when the property is sold); and use the resulting savings to help local governments to reduce upfront charges imposed on developers, and in various other ways increase the supply of low-cost housing.
Today, Mr Eslake followed up with another brilliant article in Fairfax attacking Australia’s dysfunctional tax system for the way in which it encourages borrowing and speculating, and penalises working and saving. Mr Eslake’s comments on negative gearing are particularly insightful:
The Australian income tax system provides substantial incentives for people to borrow money to acquire property, shares or other assets with a value they expect will appreciate over time. Unlike most other countries, it has always been possible in Australia to deduct any excess of interest payments on loans taken out to fund an investment over the income produced by that investment to reduce the tax payable on wage or salary income.
Since the Howard government’s decision in 1999 to tax capital gains at half the rate applicable to the same amount of wage and salary income, a decision that was supported by the then opposition, ”negative gearing” has become a means not only of deferring tax, but also permanently reducing it.
In 1998-99, when capital gains were last taxed at the same rate as other types of income (less an allowance for inflation), Australia had 1.3 million tax-paying landlords who in total made a taxable profit of almost $700 million. By 2007-08, the latest year for which statistics are available, the number of tax-paying landlords had risen to 1.7 million, but they collectively lost more than $8.6 billion, largely because the amount they paid out in interest rose more than fourfold (from about $5 billion to more than $20 billion over this period), while the amount they collected in rent ”only” slightly more than doubled (from $11 billion to $24 billion), as did other (non-interest) expenses.
If all the 1.2 million landlords who reported net losses in 2007-08 were in the 38 per cent income tax bracket, their ability to offset those losses against their other taxable income would have cost more than $4.8 billion in revenue forgone; if (say) a fifth of them had been in the top tax bracket, then the cost to revenue would have been more than $5 billion.
This is a pretty big subsidy from people who are working and saving to people who are borrowing and speculating (since those landlords who are making ”running losses” on their property investments expect to more than make up those losses through capital gains when they eventually sell them).
And it’s hard to think of any worthwhile public policy purpose that is served by this subsidy. It does nothing to increase the supply of housing, since the vast majority of landlords buy established properties. Precisely for that reason, it contributes to upward pressure on the prices of established dwellings, thereby diminishing housing affordability for would-be home buyers.
It’s also hard to reconcile this subsidy with the government’s stated aim of increasing participation in the workforce, especially when abolishing it could help pay for reducing some of the high effective marginal tax rates faced by those contemplating moving from taxpayer-funded benefits into paid employment.
The revenue forgone through negative gearing could alternatively be used to build nearly 20,000 new ”affordable” homes each year, making substantial inroads into the massive shortage of affordable housing.
Supporters of negative gearing argue that its abolition would lead to a ”landlords’ strike”, driving up rents and exacerbating the shortage of affordable rental housing. They point to ”what happened” when the Hawke government abolished negative gearing (only for property investment) in 1986, claiming that it led to a surge in rents, which prompted the reintroduction of negative gearing in 1988.
This assertion has attained the status of an urban myth, but it isn’t true. Rents (as measured in the consumer price index) did rise rapidly (at double-digit annual rates) in Sydney and Perth, but that was because in those two cities, rental vacancy rates were unusually low before negative gearing was abolished. In other state capitals (where vacancy rates were higher), growth in rentals was either unchanged or, in Melbourne, actually slowed.
Suppose, however, that a large number of landlords were to respond to the abolition of ”negative gearing” by selling their properties. That would push down the prices of investment properties, making them more affordable to would-be home buyers, thereby reducing the demand for rental properties in almost exactly the same proportion as the reduction in their supply.
And that, of course, is the reason why negative gearing will forever remain untouched – because the negative reaction and loss of votes from people who would experience declines in the value of their properties would outweigh the positive reaction from people who would benefit from lower property prices and would change their votes accordingly.
It’s something to remember next time you hear a politician saying he or she is committed to improving housing affordability, or increasing participation in the workforce, or both.
Over many years, Mr Eslake has shown great consistency in advocating to abolish wasteful policies like negative gearing and cash grants to home buyers, in exchange for reforms that lower tax rates across the board and remove disincentives to work (e.g. high effective marginal tax rates).
Taking such a principled stand must not always have been easy. After all, Mr Eslake’s employer for 14 years – ANZ bank – stood to lose directly from any moves by government that restricted negative gearing and/or reduced the first home owners’ grant. Yet despite these potential conflicts, Mr Eslake possessed the fortitude and character necessary to lobby publicly for more equitable and efficient policies.
I, for one, want to thank Mr Eslake for continuing to fight the good fight.