Negative gearing on the nose

Over the past two months, the calls to wind-back negative gearing have grown louder, spearheaded by Fairfax media.

In early March, Fairfax’s Michael McNamara wrote a fantastic article arguing to abolish negative gearing. This article was followed up in Fairfax by Saul Eslake, who lambasted Australia’s dysfunctional tax system, especially negative gearing, for the way in which it encourages borrowing and speculating, and penalises working and saving.

Then last week, Fairfax published an article noting that the Gillard Government is considering curbing negative gearing for multiple investment property holdings.

And on Monday, Saul Eslake followed up last month’s piece with another fantastic article in Fairfax once again attacking Australia’s tax system for encouraging borrowing and speculating, and penalising working and saving. Mr Eslake’s article covers a number of aspects relating to Australia’s tax system, and I encourage you to read it for yourself.  I have reproduced the sections pertaining to negative gearing below, together with some charts for additional context.

Very few other ”advanced” economies are as generous in their tax treatment of geared investments as Australia is.

In the United States, for example, investors can only deduct interest incurred on borrowings undertaken to buy property or shares up to the amount of income (dividends or rent) earned in any given financial year; any excess of interest expense over income (as in a negatively geared investment) must be ”carried forward” as a deduction against the capital gains tax payable when the asset is eventually sold.

In Australia, by contrast, where interest on borrowings undertaken to finance the purchase of a property or shares exceeds the rent or dividend income generated by those investments, that excess can be deducted against a taxpayer’s other income (such as wages and salaries) thereby reducing the amount of tax otherwise payable on that other income.

The Howard government’s 1999 decision to tax capital gains at half the rate applicable to wage and salary income, converted negative gearing from a vehicle allowing taxpayers to defer tax on their wage and salary income (until they sold the property or shares that they had purchased with borrowed money), into one allowing taxpayers to reduce their taxation obligations (by, in effect, converting wage and salary income into capital gains taxed at half the normal rate) as well as deferring them.

As a result, negative gearing has become much more widespread over the past decade, and much more costly in terms of forgone revenue.

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 taxpaying landlords who in total made a taxable profit of almost $700 million. By 2008-09, the latest year for which statistics are available, the number of taxpaying landlords had risen to just under 1.7 million: but they collectively lost $6.5 billion, largely because the amount they paid out in interest rose almost fourfold (from just over $5 billion to almost $20 billion over this period), while the amount they collected in rent ”only” slightly more than doubled (from $11 billion to $26 billion), as did other (non-interest) expenses.

The data Mr Eslake is referring to is provided in the below charts, which have been derived from the Australian Taxation Office (ATO) Taxation Statistics.

First, consider the number of property investors reporting to the ATO over the years 1999-00 and 2008-09:

Second, consider the overall value of net rental losses over the years 1999-00 and 2008-09:

Anyway, back to Mr Eslake’s article.

If all the 1.1 million landlords who in total reported net losses in 2008-09 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 $4.3 billion in revenue forgone. If, say, a fifth of them had been in the top tax bracket then the cost to revenue would have topped $4.6 billion.

(The revenue forgone through negative gearing was lower in 2008-09 than it was in 2007-08, because the number of taxpayers reporting rental income fell by about 51,000 (presumably as a result of the global financial crisis prompting some landlords to sell their properties), and because the substantial decline in interest rates after the onset of the financial crisis meant that fewer landlords paid more in interest than they received in net rent.

A breakdown of investment property holdings by income group is provided below. This chart shows that 78% of all investment properties in 2008-09 were held by individuals earning less than $80,000 per annum. In addition, 66% of investment properties were negatively geared.

Back to Mr Eslake’s article.

The figures in the previous paragraph also exclude revenue forgone through negatively gearing of share portfolios or other investments, on which no details are available.

This is a pretty large 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 sell the properties.

And it’s hard to think of any worthwhile public policy purpose that is served by it. It certainly does nothing to increase the supply of housing, since the vast majority of landlords buy established properties: 92 per cent of all borrowing by residential property investors over the past decade has been for the purchase of established dwellings, as against 82 per cent of all borrowing by owner-occupiers.

The below charts confirm Mr Eslake’s findings that investors are overwhelmingly choosing to invest in existing dwellings, thereby, they are not adding to rental availability or affordability. First, consider the percentage of investor mortgages going to existing dwellings versus new construction.

As you can see, the share of investment in new construction has fallen for the past 25 years, from around 60% in the mid-1980s to 6% currently. So despite the favourable tax treatment provided to property investors in Australia, for every 17 investment homes purchased in December 2010, only one was a new dwelling that actually added to housing supply and rental availability.

Second, as shown below, investor loans for new construction have remained relatively flat for the past 25 years whereas loans for second-hand properties surged from around 2000 onwards, coincident with the reduction in Capital Gains Tax.

As a comparison, the ratio of investor lending for existing dwellings to new dwellings was around 2:3 in 1985; 7:1 in 2000; and 16:1 currently.

Again, back to Mr Eslake’s article.

Precisely for that reason, the availability of negative gearing contributes to upward pressure on the prices of established dwellings, and thus diminishes housing affordability for would-be home buyers.

Supporters of negative gearing argue that its abolition would lead to a ”landlords’ strike”, driving up rents and exacerbating the existing shortage of affordable rental housing. They point to ”what happened” when the Hawke government abolished negative gearing (only for property investment) in 1986, claiming it led to a surge in rents, which prompted the reintroduction of negative gearing in 1988.

This assertion has attained the status of urban myth. However, it is not true. If the abolition of negative gearing had led to a landlords’ strike, as proponents of negative gearing usually assert, then rents should have risen everywhere (since negative gearing had been available everywhere). In fact, rents (as measured in the consumer price index) actually only rose rapidly (at double-digit rates) in Sydney and Perth. And that was because in those two cities rental vacancy rates were unusually low (in Sydney’s case, barely above 1 per cent) before negative gearing was abolished. In other capitals (where vacancy rates were higher), growth in rentals was either unchanged or, in Melbourne, actually slowed.

The below chart once again supports Mr Eslake’s findings. It shows real (inflation-adjusted) rents for the Australian mainland capital cities. The first vertical dotted black line shows the beginning of the ‘ban’ on negative gearing (July 1985), whereas the second vertical dotted black line shows its reintroduction in September 1987.

According to the ABS, between July 1985 and September 1987, rents rose in both Sydney and Perth but were either flat or falling in the other major capitals.

Back to Mr Eslake’s article.

Notwithstanding this history, suppose 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, allowing more of them to become home owners, and thereby reducing demand for rental properties in almost exactly the same proportion as the reduction in the supply of them.

It’s actually quite difficult to think of anything that would do more to improve affordability conditions for would-be home buyers than the abolition of negative gearing. It would certainly do more than continuing to give large amounts of cash to would-be first-time home buyers through grants or stamp duty concessions, which historically have served only to increase the prices of existing dwellings and ended up in the pockets of vendors.

There’s absolutely no evidence to support the assertion made by proponents of the continued existence of negative gearing that it results in more rental housing being available than would be the case were it to be abolished (even though the Henry review appears to have swallowed this assertion).

Most other advanced economies don’t have negative gearing: yet most other countries have higher rental vacancy rates than Australia does. In the US, which doesn’t allow negative gearing, the rental vacancy rate has in the past 50 years only once been below 5 per cent (and that was in the March quarter of 1979); in the 10 years before the onset of the most recent recession, it has averaged 9.1 per cent. Yet here in Australia, which does allow negative gearing, the rental vacancy rate has never (at least in the past 30 years) been above 5 per cent, and in the period since negative gearing became more attractive (as a result of the halving of the capital gains tax rate) it has fallen from more than 3 per cent to less than 2 per cent. During that period, rents rose at a rate of 0.8 percentage points a year faster than the CPI as a whole, whereas over the preceding decade, rents rose at the same rate as the CPI.

I’m not advocating that negative gearing be abolished for property investments only, as happened between 1986 and 1988. That would be unfair to property investors. I think negative gearing should be abolished for all investors, so that interest expenses would only be deductible in any given year up to the amount of investment income earned in that year, with any excess carried forward against the ultimate capital gains tax liability, rather than being used to reduce the tax payable on wage and salary or other income (as is the case in the US and most other ”advanced” economies).

But I’d settle for the recommendation of the Henry review, which was that only 40 per cent of interest (and other expenses) associated with investments be allowed as a deduction, and that capital gains (and other forms of investment income, including interest on deposits) be taxed at 60 per cent (rather than 50 per cent now) of the rates applicable to the same amounts of wage and salary income.

This recommendation would not amount to the abolition of negative gearing – it would just make it less generous. It would be likely, as the Henry review suggested, ”to change investor demand towards housing with higher rental yields and longer investment horizons [and] may result in a more stable housing market, as the current incentive for investors to chase large capital gains in housing would be reduced”.

I could even accept the Henry review’s recommendation that ”these reforms should only be adopted following reforms to the supply of housing and reforms to housing assistance” that it makes elsewhere, even though I disagree with the Henry review’s concern that these reforms ”may in the short term reduce residential property investment”.

Sadly, these recommendations were among the 19 that the Treasurer explicitly ruled out when releasing the Henry review in May.

That makes it hard to believe that this government (or indeed any alternative government) is serious about increasing the incentives to work and save – or at least, about doing so without risking the votes of those who borrow and speculate, in effect subsidised by those who don’t, or can’t.

Thanks to the likes of Mr Eslake, the general public is growing increasingly wary of negative gearing as well as other demand-side measures aimed at stimulating the housing market.

With a bit of luck, the Federal Government will eventually sense the change of mood in the electorate and seize the opportunity to reform Australia’s destructive housing policies (including also Australia’s restrictive urban planning system).

At a minimum, the greater public awareness of these issues should make it more politically unpopular for the Government to implement additional housing stimulus. 

Cheers Leith

[email protected]

Unconventional Economist


  1. Thanks Leith for providing the charts to supplement Mr Eslake’s article. And yes just like you said – the awareness that articles like this bring to the masses is extremely welcome.

  2. It would be interesting to see how many people (percentage wise) own investment properties in a certain income group. Now it looks as if people with an income < $80.000 are more into this sort of thing whereas it probably has more to do with the simple fact that most people fall in this bracket.

    I may be socialist Eurotrash (quote from one of my US buddies 😛 ) but creating enough rental supply via non-profit housing trusts seems a better option to me, rather than providing price increasing tax incentives like this. We're not even considering the taxes lost because of this… huge burden on society.

    Could anyone tell me why housing trusts over here are so small and so focussed on (low quality) housing for (very )low-income households?

  3. Its funny you mention the role of Fairfax in covering this issue, because I have also noticed they are far more balanced in relation to their reporting on property in recent weeks.

    I think this shows they know what is coming (CRASH!) and have given up spuiking and started reporting the news somewhat objectively.

    Or maybe they got told to pull their head in and lift their reporting standards by the ACCC as they were verging on straight out misleading and deceptive conduct.

    I dont trust Saul Eslake either…I have followed his coverage of property and as a former banker the bloke always has been very pro-property. I think a lot of people are covering their ass due to silly statements said in the past about the resilience of Australian housing.

    I reckon there is a chance the negative gearing reform could be accompanies by another form of stimulus to prop up housing. There is no way they will touch NG without giving a massive sweetner to Australia’s 1.7 million property investors

    • > I think a lot of people are covering their ass due to silly statements said in the past about the resilience of Australian housing.

      I totally agree!

      • AnonNL

        “I think a lot of people are covering their ass due to silly statements said in the past about the resilience of Australian housing.”
        I totally agree!

        SO DO I.

        • I just wonder how many more of the spruikers will be saying the same things to cover their asses….. and govt officials……

    • They chip away a little at a time.

      First, it will be the proposed ‘More than one investment property’.

      This is supposed to be only 290k of them, leaving 900k untouched.

      The government will more than make up for it with greater than 290k buyers locked out / protesting, and moderate parents concerned for their kids.

  4. I have been going to and fro in my mind about whether it even rates a mention because in the scheme of things it might only be insignificant. However, judging by the income groupings that looks like raw taxable income data after net income (or more likely losses) from rental property have been taken in to account.

    Perhaps I am tarnished by my previous employment, where clients considered it a national duty to avoid tax as much tax as was legally possible, (even if it actually left them worse off!) but I would caution against taking these statistics at face value. I saw plenty of millionaires with a taxable income of less than $50,000, for any number of reasons.

    Another issue I have found interesting, which from memory has not been discussed, is that negative gearing for your average punter is nowhere as attractive as it used to be. For example, say you decided to pursue the dubious strategy, consider that marginal tax rates have steadily decreased (eg. the top rate of 48.5% has dropped to 46.5% inclusive of Medicare Levy), whilst concurrently tax brackets have expanded significantly. Some time ago if you were earning $75,000 there is no way your marginal rate would have been 30%. This suggests that negative gearing should have already, been every so slowly diminishing in popularity!

    Love the blog team, keep up the good work.

    • the concept of NG is sound, the application is not. If you invest into a small business (selling wigwams or similar) you get a deduction on the interest that you incur…. now on investment properties this is the same … but … how people offset various primiary income streams is crazy for the govt to allow to such an extent.
      eg. if I earn $180,000 and then buy a few properties and have some write offs and brimg my taxable income to say $80,000 I save a lot of tax … now in my calc I had a lot of depriation and I sell my property 367 days later for the same price I paid, but as I had depr it reduced my cost base and now I have a cap gain of the same deduction which is taxed at a 50% multiple and hence if I do this annually I can reduce my tax really easily without the market rising 1cent.
      I really think it should be based on the age of the property … older then say 5 years then zero loss allowed.

    • I dunno, mate. As pointed out above, the incentive to take on negative gearing (high income tax rate) is not nearly as pressing as it once was. Additionally, I think that there are a lot more voters who DON’T own an “investment” property, than there are that do.
      But, as good ol’ Dubbya said:

      “BRING IT ON”!

  5. “But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.” – John Maynard Keynes, ‘The General Theory of Employment, Interest and Money’ (1936), Book VI Chapter 24, p.383.

  6. I note that The Australian published a scaremongering article on the potential modifications to the NG rules yesterday.

    It was terribly written and cherry picked a bunch of stats that didn’t actually address anything, but served to raise concerns that every single one of the 1.1Mill NG investors would dump their houses the instant the NG were modified. Even though there is only discussion that these will be applied to people with more than 1 investment property. Terrible journalism. Shame they don’t allow comments…

  7. Leith

    Thanks for another excellent piece.

    To my mind the NG emperor is now definitively exposed as intellectually bereft and morally bankrupt.

    So – time to move on. Can we come up with ways forward that would be even remotely palatable to a pollie with an average level of courage?

    That’s where I get stuck. I really, really hope that there is a solution.

    The challenges we need to surmount include (and there are probably more):

    – since NG is bankrolling the retirements of large numbers of Boomers (yes, at the expense of younger people who need an affordable roof over their heads), then removing NG would generate a lot of unhappy Boomers. Not a prospect that a pollie would relish.

    – since NG has driven the housing bubble which has driven the profits of the banks and their surrounding industries (yes, while massively increasing our exposure to foreign financial market fluctuations), then removing it would likely crash the banks’ share prices and de-feather a lot of comfortable nests at the top end of town. Again, not politically attractive.

    Now that the economic case against NG is established (if not successfully sold across the community as a whole) I’d be interested in seeing a politically focused analysis examining how best to achieve the goal of getting rid of it.

    • Thanks Ian. I provided a broad action plan in my first post on this issue last year (here):

      “Negative gearing’s cost to the Government and impact on house prices would be greatly reduced if, from a certain date in the future, it was retained on newly constructed dwellings but abolished where an investor purchases an existing (‘second hand’) dwelling. In this way, pre-existing investment property owners would not be disadvantaged and, over time, tax deductible interest would begin to fulfil its economic purpose of encouraging real investment – the production of new housing supply – as new investors enter the housing market. Such an approach, once understood, would likely be supported by the home building and property development industry because it promotes higher building levels. Further, the increased housing supply would be likely to increase the availability of rental properties and lower rents. Of course, those groups with a direct interest in long-term house price appreciation would strongly object to such an approach including, perhaps, many current Australian home owners who (wrongly) perceive that their wealth is increased when their home value rises.

      Tax purists might also disagree with such a change to negative gearing on the basis that it is wrong to discriminate among financial assets. My response is that housing is an entirely different type of asset from other financial assets, like shares. Firstly, housing is a social asset and shelter is a basic human need. Second, those buying other financial assets are bidding against other investors that can also access interest deductibility. However, with housing, the main other bidders are owner-occupiers that do not have access to this advantage (interest deductibility). So we are not comparing ‘apples with apples’ with regards to housing versus other financial assets”.

    • Ian,
      Just a small point regarding NG and retiring Boomers. Once the Boomers are retired, they don’t really have a lot of need for NG, given that they probably aren’t in a particularly high tax bracket, and given the tax concession for seniors (From memory, a couple over 65 can earn around $52k or so tax free). I’d even stick my neck out and hypothesise that many of the pre-retirement Boomers are not on such a good stick that NG is really all that useful – given our propensity for shunning older workers for the higher-paid jobs in our society. So, I’m not sure they would present an insurmountable political obstacle.
      And one thing that intrigues me about this use of the term “Boomer” is how it seems to mean different things to different people. The peak of the post-war “baby boom” was 1947 as far as I know. After that, the birth rate went into slow decline. I have seen reference to people born up to the late 50’s as “Boomers” – but I really do wonder, when is a Boomer not really a Boomer, and just a middle-aged Australian who saw a way to make a quick buck?

  8. Everyone exhale and say “I told you so” out loud. Then pat yourself on the back for not believing the mainstream marketing, I mean, journalism over the past few years.

    Let’s see if a correction actually comes though, or if the collective resources of everyone with a vested interest in property staying or growing in price will find some new way to repackage and market it to the masses.

  9. My own gut feeling is that removing negative gearing will create a far better outcome for renters and housing in Australia more generally after a somewhat volatile transition period (it’s going to a volatile period anyway).

    I would imagine that when residential real estate earns a reasonable return businesses will pop up to build and rent housing of a reasonable standard, without having to compete to buy land from mum and dad investors happy to enter into a loss making investment to reduce their taxes.

    These business might compete to attract good tenants by offering better rental conditions etc, and would have an eye for their own reputation leading hopefully to better customer service, especially in the maintenance area.

    This pressure would force mum and dad investors to compete on the quality of their rental offerings.

    Maybe it’s just me, but when people begin to make money on the service they provide (the rent of a home) and not on speculation, they might consider focussing on providing a better service.

    • Very very good points.

      When I first came to Sydney from London, as an ex landlord myself, I was frankly embarrassed at some of the crap I was shown round for rent.

      I soon realised why maintenance was not high on a landlords priorities, what with the appalling yields.

  10. I would be very happy for negative gearing to be removed, prompting property investors to rush for the exits. Those who hold on would probably try to raise their rents as much as they can get away with, yet many would lose out eventually as the number of available renters would decrease.

    But let’s be realistic – does any government have the common sense and the fortitude to bring about such a change, in the face of inevitable and forceful opposition?

    Nevertheless, I am optimistic that the very discussion about removing ng might now sow a seed of uncertainty in potential investors, which in itself might bring about a property downturn. So let’s keep the anti-negative gearing argument alive in the msm!

    • Considering both parties have knocked back getting rid of the wasteful Baby Bonus, I think NG going is nigh on impossible.

      And I say this as someone who is expecting – I even think the paid maternity leave program is a frightful waste of public funds, it should be paid out of super.

      But getting people to save, instead of speculating or relying on government services is also nigh on impossible in this country.

      • “But getting people to save, instead of speculating or relying on government services is also nigh on impossible in this country.”

        A vicious cycle, chicken or the egg I would say.

        Do you prosper in this country by saving? or do you prosper by leveraged speculating?

        This should give you the answer to the expectation of government underwriting risk.

      • Consider this fact Rusty, I originally was studying to be an aeronautical engineer, but am now a dyed-in-the-wool highly leveraged speculator.

        With inflation adjusted saving rates in the 0-1% category, BEFORE TAX, why would you save?

  11. I’m a bit dubious of claims that negative gearing is the cause of, or even a significant contributor to the housing bubble, or the hints that if negative gearing is taxed differently everything will be OK. To me negative gearing seems much more like a symptom of the bubble, with other tax issues (eg the changes to CGT, low taxes on land, too low interest rates) having had a bigger effect.

    The core problem with the ways the taxation system encourages speculation and discourages working isn’t going to be tinkering around the edges of the tax treatment of negative gearing. The core problem can only be fixed by shifting the focus of taxation away from earned income and towards other activities, such as taxes on transactions, resource rents or land value taxes.

  12. The housing correction will get rid of NG wont it?? If i was paying interest on a depreciating asset id dump it ASAP b4 the losses got worse.

  13. Talking to a friend the other day he pointed out the Housing Minister and her other half have no less than 13 investment properties. Small conflict of interest!!!
    I am sure most of of politicians are in the 38.5% and above tax bracket so why in hell would they get rid of a great tax deduction that is NG. We need to rid ourselves of all politicians first to get rid of NG. Maybe I’m an optimist!!! I hope that the discussion continues to get rid of this foolish demand driven burden on our country!!!
    By the way, like Leith, I have an investment property. Always good to hedge your bets!!!!

  14. George Plellis

    Tanya Plibersek as Federal Housing Minister also pushes this argument “any change in negative gearing would be a disaster for rental availability in this country”. Not true, currently the first home buyer is forced to compete against investors. The difference is that in bidding against Mums and Dads the investor’s advantage is that their repayments are tax deductable where the home-owner’s repayments aren’t so naturally they are in a position offer more.
    The Federal government spends nearly $3 billion a year helping investors with their mortgage repayments giving them an edge in bidding against home-buyers.
    As an investor myself I think negative gearing is causing more damage than it is worth.