Negative gearing exposed

By Leith van Onselen

Philip Soos, Master’s research student and employed researcher at Deakin University, last night gave a presentation on negative gearing. His Powerpoint is provided below. A summary article was published on Monday in The Conversation.

I have been a long-time skeptic of negatively geared property investment, as articulated in detail on my old blog in June 2010 (click to read), more recently in a Special Report on MacroInvestor, as well as in a series of other articles published on MacroBusiness in recent years.

I am sympathetic to the arguments expressed by Soos because negative gearing is a huge waste of taxpayer dollars, does little to improve the supply of housing or hold-down rents, and artificially inflates housing demand and prices. I also agree that negative gearing should be abolished (i.e. quarantined from deducting rental losses against other income) or at a minimum permitted only on newly constructed  housing.

Soos’ research report and presentation contains some great charts illustrating the extent of the problems associated with negative gearing, and debunks some common misconceptions.

For example, the below chart shows the growth of negatively geared property investment since 1993-94. Back then, there were 980,500 property investors in Australia, 500,000 (51%) of whom were negatively geared. However, by 2009-10, there were 1,751,700 property investors in Australia, 1,111,000 (63%) of whom were negatively geared.

Losses by negatively geared investors have also skyrocketted. In 1993-94, negatively geared investors racked-up $1.9 billion of total losses (-$3,800 per investor). However, by 2009-10, total losses had increased to $10.1 billion ($9,100 per investor):

Negatively geared property investment is mostly a middle-class affair, with 76% of negatively geared investors earning $80,000 or less in 2009-10:

The cost to taxpayers from negative gearing has also tripled since 1993-94, from $850 million to $2.9 billion in 2009-10:

Despite its huge taxpayer cost, negative gearing has done little to boost the supply of housing, with over 90% of negatively geared property investors buying pre-existing dwellings:

As such, the amount of investor funds going into new housing has barely shifted in 25 years:

What about the common argument that the abolishion of negative gearing between July 1985 and September 1987 caused a rental crisis, causing rents to skyrocket across the country? This claim is easily debunked by the data, which shows that rents rose in four capital cities and fell in four capital cities:

If it was true that the abolition of negative gearing caused rents to rise, shouldn’t rents have risen Australia-wide since negative gearing affects all rental markets?

In any event, I suspect the large increase in Australia’s population growth in the mid-to-late-1980s played the major role in increasing rents nationally:

Overall, Soos’ research highlights in detail why negative gearing is poor policy that should be reformed on both equity and efficiency grounds.

Twitter: Leith van Onselen. Leith is the Chief Economist of Macro Investor, Australia’s independent investment newsletter covering trades, stocks, property and yield. Click for a free 21 day trial.

Philip Soos Written Off Negative Gearing Presentation Oct 2012

Leith van Onselen
Latest posts by Leith van Onselen (see all)

Comments

  1. with interest rates on their way to Zero, this probablem will solve by itself (unless huge house price growth which still is a strong possibility), as most of them are becoming positively geared.
    speculator win.

    • What better time to scrap a tax break then, than when it doesn’t cost too many people anything? It’s coming!

    • dam

      the banks are going to pass on much of any cuts. They have to keep making record profit.

      • They usually pass most of it, if the RBA get to 2% by 2014, the rates will be 4.5% max which is totally dream bonanza, free money for investors who mostly have done their purchase with a 7-8%, all while rents increase quite fast.

        not many will be negatively geared by 2014.

        Babyboomers’ christmas gift everyday.

          • yeah those who are not property investors lose but this has been the case for years now.

            the dice are loaded

          • Well I don’t like the sound of this “robbing Peter”

            You are right, lower rates won’t help boomers who have cash, and those who do have IP’s should be positively geared by now, so the rate cut will have minimum benefit for them.

            But after a few more rate cuts and not many IP’s will be negatively geared.

            As a property investor (commercial property) I would prefer to accumulate losses and claim them when I sold. NG is just a useful tool for the REA’s on the Gold Coast to talk inexperienced investors into making a decision based on emotion but justified by a tax rule that they don’t understand.

            In the end all losses made are tax deductible. Land tax is more of an issue for large property investors.

            There is a lot of politics on both sides of this debate.

          • As a property investor (commercial property) I would prefer to accumulate losses and claim them when I sold

            That’s not investing. That’s speculating by definition.

            When I invest in property, I want positive cashflow. Just when I invest in businesses. To “invest” in an asset that has no positive cashflow is speculation – doesn’t matter what the underlying asset is – listed share, unlisted business, residential property, commercial property, gold/precious metals (all of which are speculation).

            Lets be clear on this. Allocating any capital – or borrowed capital – into an asset that does not immediately provide a positive cashflow is NOT investing. However, there is a place for this speculation in your portfolio, but it must be done with a view to risk control. More than 10-20% of your portfolio in speculation, and you better be damn sure you know what you are doing, and you have NO OTHER assets at risk (e.g your family home….) to do so.

          • I’m not going to divulge my personal financial position, but I’m certainly very positively geared, without counting the 100% or more gains that I could get if I sold.

            But if I was negatively geared, I would still prefer to claim the deduction when I sold, to diminish the capital gains – and yes if you buy well you can make capital gains.

            Just as it is incorrect to assume that you can’t make a loss, it’s equally incorrect to assume that you can’t make a gain. Keen buyers do it every day of the week in property, shares, horses, antiques, classic cars, art, stamps, rare coins, etc etc.

            Are you allowed to claim the cost of borrowing for shares?

          • Yes you can claim the cost of borrowing money to buy shares, but you shouldn’t IMO.

            Another macro-prudential tool that is required – although the latest margin lending stats bear out (sic) that people are shying away from borrowing money to buy shares, which is a good thing.

          • Margin loans are dangerous – they are not as easy to get as they once were, and with good reason. I wouldn’t touch them.

            Tax deductibility on loans to enable income has always been in effect. It doesn’t actually cost the tax payer anything, which is why they keep it.

            What it does do is create winners and losers, and that is politically unpalatable for the losers.

          • Spot on TP. I posted the following a few days ago.

            “You see, last time I checked, renting a car was quite expensive. I could see that Hertz must be making good money by purchasing cars and renting them out. I simply cannot see the same for the property investors here.”

            Do you think Hertz (or their peers) would ever run with negative cash flow? I don’t think so!

          • Is margin loan dangerous? I did take margin loan for the first time last September, because shares were so cheap (LVR is modest).

            Basically I think across the board price rise (inflation) is likely and I want to hedge myself.

            I want my e.g., WPL shares to pay my petrol bills, WOW shares to pay my grocery billes, ORG shares to pay my electricity bills, TLS shares to pay my phone bills, …

            I am not quite there yet, but getting close. I also need to find a stock that can pay my rent!

  2. I am always a little skeptical of the data that says most of the investment properties are held by middle class people. Does anyone know how the data is captured?

    For example, if I earn $100k and make a $30k loss on an IP, am I counted as having earnings of $100k or $70k?

    Cheers,

    h.

  3. You have to factor in the boom in house prices in the last 10 years making it more difficult to positively gear.

    Back in 2000-2001 I was buying rental properties in NZ with 10% deposit that (at 7% market rate) were on 15-year fortnightly mortgage payments and were *still* positively geared. Since around 2005 that has been impossible to do given those house prices doubled and rental income rates increased maybe 10%.

    There are a few places in NZ that are just now creeping back towards prices that would allow positive gearing with maybe a 20% deposit.

    So maybe other factors rather than just a rush to negatively gear help explain the rise of negatively geared rentals. I certainly can’t imagine many people being positively geared in the current Sydney investment property market.

      • You know, I think you have a point there;

        I personally don’t understand why anyone would think that negative gearing is a good “investment” as it seems to be predicated on a single outcome paying off (further house price inflation) and all others leaving me with losses.

        But I’m not Australian. From what I’ve observed, the Aussie psyche is deeply addicted to the horses, the pokies, sports betting on their smartphones, etc. 1 in 50 Australians has a problem with gambling addicition (http://thenewaustralian.org/?s=gamble), perhaps the figure is larger but the rest are balls-deep in property instead?

        Negative gearing is really nothing more sophisticated than sticking all the chips on “red” and crossing your fingers as the roulette wheel is spun.

        • The most important thing about negative gearing is that you’re getting one over on The Man and paying less tax.

          All other considerations are secondary.

        • I personally don’t understand why anyone would think that negative gearing is a good “investment” as it seems to be predicated on a single outcome paying off (further house price inflation) and all others leaving me with losses.
          You are correct in that you don’t understand.
          However you are wrong about the scheme depending on house price inflation. The scheme will work IF RENTS RISE ENOUGH.
          (which they have done in the past)

          • Got it, thanks for the help.

            So, if rents rise enough and/or house prices rise enough I win otherwise it’s a loss and a leveraged one at that.

            I’ll stick with my term deposits and shiny yellow metal coins for the moment, thanks.

          • The scheme will work IF RENTS RISE ENOUGH.
            (which they have done in the past)

            The scheme will work IF I STAND INSTEAD OF HIT
            (which has worked in the past)

            Sounds like a gambler to me.

  4. So, if negative gearing ever gets abolished and it actually affects people enough to have to sell their properties at a loss and cry themselves to sleep – wouldn’t the government and the banks just bail them out anyway?

    Kinda like Storm financial? – “I didn’t realise it was risky to retain my gearing levels as high as they could go and keep borrowing against my house, can I have all my cash back please”

    • Would make Storm Financial look like a picnic.
      The lenders are well aware of the risks and then went ahead and enabled the current debt-binge, the banks would deserve any class action for negligence and irresponsible lending that borrowers threw at them.

    • Easy! (not easy to implement for gutless politicians)

      Each individual required to file two tax returns, one for wage incomes and the other for investment incomes. The indexation only applies to the wage incomes. A flat rate that matches the corporate tax rate applies to the investment incomes.

      Capital gains are only deductible against capital losses and taxed at half the corporate tax rate. Costs of investments are only deductible from the investment incomes. Plus the GST and the broad based land tax.

      Simpler, fairer, more equitable and evasion resistant!

  5. I’m not a fan of negative gearing but I do find amusing that calls of abolition occur once the baby boomers are nearly done with it.

    Us Gen-X/Y’ers are finally able to crawl onto the property ladder and then the rules are likely to change. We won’t be able to ‘build wealth’ as the previous generation did for the past 20 years!

    • This, my friend, is the hard hard fact facing our generations. The boomers have enjoyed a golden era, not least in regards to opportunities for consumption (predicated on asset appreciation). Their legacy to us: a debt mountain and terrifically lop-sided demographics. Our obligation in this context: a healthy degree of parsimony and growth predicated on the production of things with true value. I used to laugh at my depression-era grandparents’ extreme penny pinching, now I see its great virtue. They were very happy people.

      • Our masters like to turn our parents against us, it is amusing to them. How readily our parents fucked us over for their own pointless retirement… sad. Anyone with NG parents should squat their parents second house.

    • Haha totally agree – this is the great paradox of the ‘success’ against negative gearing (which i have mentioned before).

      That 3,000,000,000 in taxes is needed for other things now and the boomers will be happy to let it go.

    • yes – i love the fact that the govt is now a creditor for the banks, and if it ever needs to retrieve its investment after a bank failure, it can retrieve it from the bank’s deposit holders whom it also happens to guarantee. A perfect circle!!! The govt now covers ALL investor risk, and the banks get to lend more at lower rates due to the free AAA(?) insurance. WHAT A FARCE!!!

  6. itsonlyrockandroll

    Let’s get the terminology right, gang! When a bank gives you money you don’t have, to buy an investment protected by other non participating peoples money and a political class totally committed to making it see a return, it ain’t negative gearing, it’s really called negative fearing…..

  7. Leith I think that both you (in your post in June) and Philip Soos have understated a really significant aspect of negative gearing – and that is claiming depreciation of assets in an investment property.

    The cash flow after costs, interest etc can be positive for a property, however after the depreciation kicks in the investment can still ensure a net “loss” from a taxation perspective. This can make a cashflow positive investment even more profitable for the individual after tax, and cost the taxpayer even more.

    Well worth your reviewing how sizable this extra kicker is in the overall picture. Although it doesn’t change the basic thrust of your message re: negative gearing (which i broadly agree with btw) it highlights aspects of the design of the policy that I suspect were added to support new construction and/or development of existing dwellings as it heavily weights new builds vs. existing.

    One of your charts from your post quantified this from ATO data but you didn’t talk to this specific aspect (from memory). I suspect any policy reform that is likely will focus on reducing the extent of depreciation benefits… and rightly so.

  8. Ah, the bogeyman negative gearing…

    I must admit that there are quite a few people who cannot understand the concept no matter what their “credentials” are (mind you, many prominent economists and media personalities are in this camp).

    Let me just pick on this example as either a case of inability to count/ or purposeful manipulation of figures (make your pick):

    “…However, by 2009-10, total losses had increased to $10.1 billion (?????)”

    The source is apparently ATO but have a look at Table 16: Personal tax

    Rental property schedules, by state of property, 2009–10 income year

    Rental and other property income: $27,680,376,449
    Rental Property Expenses: $32,773,868,948
    Net rental income: -$5,093,400,714 (discrepancy of ~90k due to rounding)

    That’s half of the purported amount for 2009/10.

    Mind you “loses” do not equal “taxpayer subsidy” as taxes are reduced by only ~30-35% of that amount (!). And the amount is not $2.9B for 2009/10 as implied above but only about $1.8B

    And for those who still don’t get it, the amount of tax paid over time is almost identical under “no negative gearing” and “negative gearing” scenarios – only the timing is different. It is not a “cost to taxpayers”… Negative gearing is not a tax rort… I am indifferent about whether negative gearing is abolished or not but if you feel strongly that it should be, get your facts = expectations right because you may by “surprised” when the change is not delivering the expected “benefits”.

    • I suggest you get your facts right before commenting here again. The $10.1 billion figure relates to losses incurred by negatively geared investors only, as articulated in the article. The table you quoted does not seperate-out postively geared and negatively geared investment.

    • Not sure about that – the argument that it’s only a timing difference would only hold water if the tax rates are the same at the time of gearing and at the time of sale. I’m not sure you’ve made a case for this as capital gains tax is only on the 50% discounted gain, and many sell the IPs when their income is lower – so there probably is an arbitrage benefit of some sort going on here.

      In any event, to just dismiss it as a timing benefit kinda misses the point. Negative gearing provides a cash-flow benefit (funded by the tax-payer) that allows an ‘investor’ to speculate in property at a reduced interest rate. That’s the point isn’t it – given that the interest expense is probably the single biggest cost of a speculator there is a reasonable case to be made that this flows into the price a speculator can carry and feeds into the market as a price setting mechanism.

  9. Negative gearing is slowly unwinding thru

    1. lower tax rates = less benefits to investor
    2. lower interest rates = less deductions = less benefits to investor
    3. lower depreciation after first couple of years = less deductions = less benefits to investors
    4. rents starting to creep up = lower losses = less benefits for investors

    Would be interesting to assess the impact of dropping the middle class / middle tax rate to 25% – suspect that the negative gearing impact would substantially reduce the overall cost to the government.

    My big worry is the soon-to-retire people with big property debts. Compulsory super has not helped them. Being able to borrow within super funds is proving to be a good way to wipe out retirement funds. Kellyresearch report for CPA Australia makes some sobering reading. Shame the data years are 2002, 2006 and 2010 – would have been good to see some 2008 numbers.

    • Tax Rates have been cut significantly (from high levels) over the last decade on the back of Australia’s favourable demogrsphics, the benefits of some good long term supply side policy (mostly Keating and some Costello) and the very favourable mining boom.

      Australia now has faces less favourable demographics, less benefits coming through from good policy (it’s mostly been feel-good, destructive demand-side policy – in my opinion, stupid policy) and, significantly, an end to the huge mining party/boom.

      Therefore, personal tax rates will have to go back up. Middle classes might be back at 40% (or even a shocking 50% in the extreme case) sooner than expected.

      This may seem impossible. It’s not. I’m still young. My parents are boomers. They were certainly not rich. It’s a stretch to say they were even middle class. I remember them losing (bank forclosure) a tiny house in outer Melbourne. My dad was in the plus 50% marginal rate!!!!!! It was not that long ago.

      In these circumstances (huge govt deficits and increasing taxes), NG will become a major/hot. Expenses against income must always be allowed. US-Reasonable limits on offsetting property losses against other personal income each year will almost certainly be introduced.

      • The analysis misses the point that it’s a “zero sum game”. Over a medium to long term the amount of tax received by tax office will be equal (minus some anomalies caused by changes to tax brackets and the like) under NG and no-NG scenario. That is, if NG is abolished the “saving” in the first few years will be offset by less tax paid if future years (as investors will be claiming losses against future rental income). So, the negative gearing only affect the timing of tax, not the total amount paid/received over time. Therefore claiming it’s “a cost to taxpayers” is misleading and shows lack of understanding how negative gearing really works.

        • Your argument assumes that the investor holds the property into perpetuity, in which case the carry forward losses would eventually be wiped-out as rental income eventually exceeds holding costs. But we all know that many property investors sell before the property becomes positively geared.

          • Not in perpetuity. Under NG scenario a property will start to generate taxable income in 5-8 years on average.

            No argument that some will sell while still making loses from renting but will pay tax on any capital gains. There will also be very, very small proportion of investors who just give up mid way and/or sell for portfolio rebalancing reasons (no different to share ownership) and realise losses and offset against other income. But the vast majority will hold long term as this is the only sure way to make a decent return.

            Again, the full picture is the key, not the piecemeal approach. You can find examples of rorts in any activity, investment or not, but these should not be used as prime examples why something “is evil”. The danger of doing so is that it creates unreasonable expectations. Eg. abolish negative gearing = “billions in tax savings”, “cheaper houses” etc., etc. Those who buy into these arguments may be disappointed unless they understand how the system works on a macro scale.

          • Capital gains are taxed at half the MTR, so the tax office would lose out. By way of example, a close relative of mine was a high income earner making $200k a year and owned four investment properties, all of which were negatively geared. He sold them once he retired (no longer earning an income) and paid minimal CGT. How is this situation revenue neutral?

            I can assure you that this is not an isolated situation – boomers own almost 60% of investment properties by value, many of which would be negatively geared.

          • Generalisation is another common oversimplification of the issue. Because “it happened to a relative” of yours doesn’t mean everybody is onto it. Just look though statistics… there aren’t as many property investors with incomes of $200K and 4 properties… We need facts in this debate, not opinions. You are an economist, model it! I am sure readers of this blog will be very interested in the results.

            As a side issue, of course I don’t know the full financial situation of this guy but I would not be surprised if he got a raw deal from his “financial advisers” – and lost “the windfall” in a sharemarket and/or his superfund. I could argued he is another point in case/ victim of gross misunderstanding of negative gearing because there are no compelling reasons to sell the investment property when you retire.

          • You are the one who is delusional arguing that negative gearing is revenue neutral. Are you seriously trying to say that there aren’t lots of investors that hold negatively geared properties for a few years and then sell before they ever turn positively geared? Funny, because I know lots of people that have flipped negatively geared houses. They claimed full MTR tax deductions whilst they held the loss-making property, and then paid half the rate on any capital gain.

            Revenue neutral my arse.

          • The proper baseline from which whether gearing generates more or less revenues for the ATO can be measured is; nobody borrows a cent.

            If you borrow money to invest (regardless of whether you are positively or negatively geared) the interest you pay is your financial institution’s income. I am pretty sure that the ATO will tax that from your financial institution. Will the ATO be better off if you borrow money to invest at all? Absolutely!

            Now for capital gains. In a period for which the GDP growth is negligible, and in the absence of a *hidden tax* of inflation, a share market is a zero-sum game (the same can be said for a property market over a full cycle of boom and bust). There are equal amounts of capital gains as capital losses. By taxing the CGT at half the marginal tax rates AND paying no tax refund at all for capital losses, the ATO is GUARANTEED to win (here the baseline is no movement in a market at all).

    • The net effect, the one worth paying attention to, is that tens of billions of dollars are being biased towards residential property speculation – an endeavour that is dragging this country further and further away from its ever increasingly dire need to create a more competitive economy. It is denuding more important industries, de-skilling Australians, making us lazy, complacent, and ever more vulnerable to becoming mired in decades of lower and lower growth. There is NO other point in your argument.

  10. This is idiotic research. Do not be blinded by the statistics!

    As an experienced property investor (approx 100 property purchases), I agree that Australian property prices are excessive (especially in Melb, Syd, Perth and a few other areas).

    However, a property is just like a business. Tax should be calculated on profit which is Income less genuine expenses.

    The idea of limiting the “losses” that could be offset against other personal income (as happens in the USA – so there is a real world case study) has some merit and may be worth looking at.

    The statistics in this “presentation” about the rentals not increasing so much when negative gearing was last abolished is nonsense. Pick slightly different date periods or criteria and the statistics results change dramatically.

    The presentation overlooks that many private investors proactively renovate and improve properties. There is innovation, creativity and individualism happening. What is the alternative? The UK and Europe have lots of “social housing”. It’s awful for all concerned. The government departments lack creativity and disciplines. It costs far far far more. Tenancy decisions are made on preferential, priveliged or corrupt basis. Example – in the UK, there are union leaders earning well over £100,000 per year who also have a “Council House” and they vehemently defend their right to their council house.

    As someone who has worked and invested in different countries, there is absolutely no question in my mind that it is far better to open up the property market to private investora rather than have Social or Govt housing.

    As far negative gearing, I manage my portfolio carefully so overall the income and expenses are roughly the same. This is something I’d encourage all investors to aim for.

    I agree that high earners negative gearing just to reduce their tax is poor investment and of little benefit to the country. In my experience, the negative gearers are the investors who often don’t want to improve their properties (because they are already making a loss each year).

    To the Researchers/Authors: I promise you that unless you have owned at least 10 properties and had to deal with managing, improving, looking after them etc etc for a few years, there is just you can no way in the world that possibly understand what is really involved or what is really happening. You wouldn’t have seen all the tenants on disability payments (I can’t possibly work) who go horse riding regularly or who offer to paint a house inside and out in return for a cash payment. This things don’t show up in statistics but I have seen them many many times in Australia. The point is there is no way that the government (social housing) can prosibly deal effectively with these things. They will sit at a computer screen in Canberra or a capital city compiling statistics but miss much of what really happens!

    • Statistics dont’ always capture the reality. This is a valid point. Otherwise, your argument in favour of biasing investment towards property as a means of contributing to the national good is beyond idiotic. This is the kind of mentality that is dragging this country into the toilet. Property investment is completely non-productive – it’s effects are ephemeral. It is doing nothing to increase our ability to compete in the global economy, and has diverted investment away from building a stronger and more diversified industrial base. It is a monumental ponzi scheme underwritten by populist government and their central bank cronies, and unsurprisingly preferred by the mentality that expects to create wealth from doing NOTHING of economic substance.

    • arescarti42MEMBER

      “However, a property is just like a business. Tax should be calculated on profit which is Income less genuine expenses.”

      Amazing isn’t it. If you run a business that loses money constantly without ever hoping to return a profit, you go out of business. If you own an investment property that does nothing but lose money constantly, the government pays you for it, and it is called negative gearing.

      I’ve no idea what you’re blathering on about social housing for. If your argument is that negative gearing increases the supply of housing, scroll up and read the part about how 9 out of 10 negatively geared property investors buy preexisting properties.

      So for every 9 potential homeowners negative gearers force on to the rental market, you increase the housing stock by 1.

      • “If you run a business that loses money constantly without ever hoping to return a profit, you go out of business. If you own an investment property that does nothing but lose money constantly, the government pays you for it, and it is called negative gearing.”

        Are you suggesting that negative gearers will not go out of business? How?

      • Would you call the automakers who report losses and ask for the governement funding “negative gearers”, too?

    • The presentation overlooks that many private investors proactively renovate and improve properties. There is innovation, creativity and individualism happening. What is the alternative? The UK and Europe have lots of “social housing”.

      No, the alternative is for property investment without negative gearing, as happens in most of the world.

      Your whole argument is a false dilemma fallacy. Most countries have far more functional rental markets – tenants rights in Australia are barely adequate, (and I say that as a landlord) – than ours without negative gearing.

      • +1. It is very hard to see what benefits if any investors in existing housing stock make to the community. There is almost no justification for giving them a free kick with negative gearing so they can become price setters.

        • Why do you think negative gearing is a “free kick”?

          I saw from the graph above that 76% of negatively geared investors earning $80,000 or less (i.e., their marginal tax rates are not greater than the corporate tax rate).

          If you borrow money to invest (regardless of whether you are positively or negatively geared) the interest you pay is your financial institution’s income. I am pretty sure that the ATO will tax that from your financial institution. Will the ATO be better off because of these 76% of negatively geared investors? You bet!!

          • It’s a free kick because it frees up cash-flow to cover interest expense in speculating on the investment.

            I have worked with a couple of guys that have written to the ATO to reduce their PAYG rate to cover the interest expense on a large property speculation. It might not seem much, however because of the low rates it allows significantly more gearing, and of course flows into the market as a price setting mechanism.

          • aj, I am confused.

            Let’s not talk about a time frame shorter than 1 financial year.

            Isn’t the ATO (and the taxpayer) better off because of the negative gearers whose marginal tax rates are less than that of the coporate rate?

          • It’s a fair point you raise. In theory corporate structures could be used for investment properties, and assuming they had income from another source (passive or active) the shelter would be fairly similar. (If not better, as you note, on the back of the statistics above.)

            However companies are actually pretty rarely used as investment vehicles in property for the sole reason that property investment (at the prices we are seeing) is mainly about sheltering PAYG income in the early phases. As an aside, the ATO is a loser because the reality is that nearly all of the speculators wouldn’t have had company income to shelter so there is a net loss of PAYG income tax (which is more than just a timing benefit because of the arbitrage on rates – see comments above).

            A property speculator that wants to do an interest only loan for a 1mil place at 6% is up for 60K interest per year. Assuming they are on an effective rate of 30% (and ignoring the effect of the marginal rates for this example) then this only costs them 42K (they reduce their taxable income by 60K and save 18K) – If they had to cover the PAYG tax then the best they could carry is 42K and then they are not bidding above 700k. With the gearing they are bidding at 1mil because of the negative gearing free kick.

            This is exactly how it plays out in the real world. So poor mum and dad and kids looking for a place are suddenly competing with a speculator that can bid 1mil for a place they can bid 700K for on the same income.

            And yes for those charming speculators with tens or hundreds of properties that are sheltering the income from the properties it plays out the same way. Property speculators become the price setters for a social asset that has now become a financial asset to the detriment of the entire community.

          • Aj, what I was trying to get at is different.

            Let’s say there is an individual whose marginal tax rate is 15% (i.e., the total income of less than 37k for the last FY, perhaps those who made less than 35k in 2009-2010 FY in the graph?). Suppose this individual has exactly “zero negative gearing” (investment costs exactly match investment incomes).

            Now suppose this person makes $1 extra interest payment to, say, CBA ($1 negatively geared) and deducts this $1 from his income statement.

            The ATO will collect 15c less tax from this individual. But then the ATO will collect 30c more tax from CBA because CBA raised an extra revenue of $1 from the above individual.

          • Remember the bank is only a broker in effect so it might get 1 dollar interest back but it has commitments of 95c to pay out to the depositor, taxable revenue of 5c, tax payable of 1.5c.

            But… fair point still. If the depositor was australian then the interest would be taxed here still at that level. Although most funding is from offshore, which is probably how most of the potential tax revenue creeps out the door.

          • aj, I agree that it is complex, especially once overseas interest payments by our banks come into play.

            I wonder if there is a simple first approximation calculation for this kind of stuff. I am quite interested in knowing if the ATO is truly worse off, and if so, by how much?

    • The idea of limiting the “losses” that could be offset against other personal income (as happens in the USA – so there is a real world case study) has some merit and may be worth looking at

      That is exactly what we are on about when we say “abolish negative gearing”. Nothing more. Quarantining losses against the source of income i.e. rent.

      Case closed.

      • +1. That and removing the arbitrage benefit of sheltering the initial income behind the interest expense only to get a discounted capital gain on sale.