More negative gearing scaremongering

ScreenHunter_21 Apr. 10 19.29

By Leith van Onselen

In a post-Budget newsletter last week, the “Barefoot Investor”, Scott Pape, questioned why Australia’s cash-strapped Federal Government had not considered scrapping negative gearing. From Property Observer:

“Our 1.25 million loss making landlords cost taxpayers $5 billion a year – a significant saving when the budget is in deficit of $18 billion,” writes Pape.

“And all it achieves is to make it harder for young people to compete to buy their first family home.

“Sadly, the government didn’t have the ticker to abolish it this year”…

Pape has long been a critic of negative gearing calling for its banning on talk back radio in 2011 and telling a negatively-geared listener that “negative gearing is really just a socially acceptable way of saying ‘I’m losing money’”…

“Contrary to real estate rhetoric, it does little to increase the supply of new homes, since the majority of investors buy established properties. What’s more, it costs the Australian taxpayer billions of dollars in forgone revenue,” he says…

Later in the week, well-known property investment advisor, Margaret Lomas, posted a stinging critique of Pape, arguing that the removal of negative gearing would cause dire consequences for the housing market, the economy, and society at large. Again, from Property Observer:

Lomas warned that removing negative gearing would cause a “sudden market crash” leave 600,000 homeless and a “government unable to house them under public housing programs”.

“Private housing is a must and removing the capacity to claim loan interest [under negative gearing allowances] would create far more problems than it solves,” she said…

Lomas said removing negative gearing rules –as Pape contends – would remove the ability for investors to claim the interest on their loan, “which is what negative gearing is”.

“Contrary to popular belief, removing it means you can still make tax claims for everything but the interest and probably more than half of them would sell,” she said.

Reading Lomas’ comments gives the impression that she has little understanding about what the removal of negative gearing would actually entail.

Australia is one of only a handful of countries that permits rental losses to be claimed against wage and salary income. If the Government was to modify the negative gearing rules so that they worked the same way as in most other developed economies, property investors would still be able to claim mortgage interest and other costs. The only difference would be that such costs could only be claimed against rental income, not unrelated wage and salary income, with losses carried forward into future tax years (similar to the way capital gains losses are treated).

Indeed, this is exactly what happenend between July 1985 and September 1987 when the Government “quarantined” negative gearing losses on new transactions, thereby only allowing investors to claim rental expenses against rental income, not other income.

Lomas’ claim that the removal of negative would leaving 600,000 homeless and a “government unable to house them under public housing programs” is also highly melodramatic and does not stand up to proper scrutiny.

Reserve Bank of Australia (RBA) data clearly shows that the overwhelming majority of investors – over 90% – buy pre-existing dwellings, not new dwellings, and that the proportion of investors buying new dwellings has fallen considerably since negative gearing was re-introduced in September 1987 (see next chart).

ScreenHunter_04 May. 09 10.24

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

ScreenHunter_05 May. 09 10.27

Because investors primarily purchase pre-existing dwellings, negative gearing in its current form simply substitutes homes for sale into homes for let. As such, negative gearing has done little to boost the overall supply of housing or improve rental supply or rental affordability.

In the event that negative gearing was once again quarantined and a proportion of investment properties were sold, those properties would not suddenly vanish into thin air leaving a large number of people homeless. Rather, these homes would be sold to renters, turning them into owner-occupiers. And while the number of rental properties would be reduced, this substitution of renters into owner-occupiers would simultaneously reduce the demand for rental properties, leaving the overall rental supply-demand balance unchanged.

Perhaps this is why the quarantining of negative gearing between July 1985 and September 1987 had little discernible impact on the rental market, with inflation-adjusted rents rising in four markets and falling in four markets over that period (see next table).

Surely, if negative gearing was such an important determinant of rental market health, shouldn’t rents have risen Australia-wide when it was “abolished” in the 1980s, since negative gearing affects all rental markets equally?

Finally, Lomas’ claim that removing negative gearing would cause a “sudden market crash” also seems highly melodramatic and suggests that Australian property values are based more on generous tax policies and speculative demand by investors, rather than underlying fundamentals.

While negative gearing’s removal would reduce investor demand, placing downward pressure on prices and improving affordability for first home buyers, it’s important to remember that negative gearing is not allowed in most other jurisdictions, many of whom also experienced rapid house price growth and have expensive housing. As such negative gearing’s removal is not a ‘silver bullet’ for housing affordability, although it would certainly help.

As argued last time, negative gearing has few policy merits. It does little to boost supply, yet the additional demand from tax subsidised investors places upward pressure on home prices, worsening affordability for first home buyers. It also costs the government billions in lost tax revenue, which could be used to fund schools, hospitals, housing-related infrastructure, or any number of other worthwhile endeavours.

Soon we will release a detailed research report, available exclusively to MacroBusiness members, examining the latest Australian Taxation Office statistics on negative gearing at the national, state and territory levels.

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Unconventional Economist

Comments

  1. It will only be a concern to lazy uninformed investors during times of high interest rates. For the well informed investors it’s a non-issue.

    Given that existing property investments will be grandfathered, and we are likely to be in a low interest rate environment for a long time. it’s a bit of a non-issue at the moment.

    • PF – i know lots of young professionals that are negatively geared and the main driver for this position is to shelter their personal income tax. In fact for some buying and renting out a property is the only way they think they can catch up to the property market to get a house to live in one day.

      It is true that not everyone does the hard numbers on how much they are paying the bank and how much they are paying the government – but add the historical protection of housing and the tax shelter certainly makes the difference.

      • aj. They will still get the major portion of the tax deduction against property income, and the rest of the losses will be written off against property income when it becomes positively geared over time, or against the profits on sale. The only occasion when the tax deductions are lost is when a sale loss occurs before the property has become positively geared sufficiently to cover all of the losses.

        As for the grandfathering aspect, that is what happened when Keating brought in a change, and in the vast majority of cases legislation on tax is not back dated and it grandfathers existing arrangements. That doesn’t mean the government can’t back date the changes, but bringing in changes of this nature has political risk, and back dating it could be suicide. If Britain was a nation of shopkeepers, we are a nation of landlords.

        The term “negative gearing” is a great marketing term. It suggests a monetary gain for losing money, but it’s not. A dollar tax deduction is a dollar tax deduction, only the timing of the tax claim would change for the loss portion above rental income.

        If changes are made and REA’s lose the ability to draw in uninformed investors using it as a catch phrase, I’m sure that they will find another term to use. How does “positive gearing” sound?

        Essentially negative gearing is a means of “bringing forward” a tax claim in a similar manner that “accelerated depreciation” brings forward tax losses on equipment, but it doesn’t actually change the amount of tax losses claimed.

        From an investors POV it becomes important to their cash flow when interest rates are very high, but it’s less important when rates are low. When rates are high it will place marginal investors under cash flow stress. Therefore I would expect to see less poorly capitalised uninformed investors in a non-ng tax regime, and more well capitalised professionals. That should put some downward pressure on house prices, but how much?

        A professional will be looking for a rate that competes with bank interest rates and dividends – so maybe they would want a net return of 4.5% to 5% to be comfortable, although as rents usually increase over time they may be willing to accept less initially.

        It won’t stop people investing in property.

      • rob barrattMEMBER

        AJ. The issue remains as to whether legislation should permit people to continue having this option. By giving it to them, you exacerbate the very issue they are trying to deal with – a perceived constant real increase in the cost of buying their own home. The reality is, depending on whereabouts you are in the boom/bust cycle, some will have profited while lowering their obligation to society, others will be in some form of negative equity and immeasurably worse off.
        NG is a fiscally and morally irresponsible policy, and the rats in Parliament House should be doing something about it.

      • I appreciate what you’re saying P but the personal tax shelter is a cash effect and the sheer number of near 100% loans for investment show that it is being taken advantage of.

        Without the negative gearing most of these investors wouldn’t touch it – just like most of them wouldn’t have touched the agribusiness schemes without the tax hook.

        Negative gearing should be quarantined and subject to stringent debt equity provisions.

      • “the sheer number of near 100% loans for investment show”

        And don’t forget the interest only part too.

        I’m still amazed at the amount of 100% interest only loans that are out there. You ask these people who the loans are with and it’s the big four. Don’t know if it is common, but I saw one IP purchased with 50% from Westpac and the other 50% from BOQ.

        Then it’s get out the calculator and show them how badly they’re doing their arse.

      • aj. fair enough. I’m a property investor but it wouldn’t concern me. In fact I won’t let my accountant claim depreciation on fittings etc as it will just increase my profit on sale, which is when my my tax rate will be the highest. The ATO are not stupid, eventually they will get every dollar legally owed to them. The timing really doesn’t matter that much.

        The culprit for high house prices is the shortage of houses where they are needed. We have plenty of houses but in all the wrong areas.

        I don’t think that encouraging investors into the market has made that worse, in fact I think it would probably have eased the situation. If you want to fix that then we need more houses and more infrastructure, but aspiring new buyers aren’t being tempted enough to buy or build new homes en masse. We are sort of caught in a loop that needs to be broken. Maybe that will be by lower rates or government stimulus. Honestly I don’t know what will break it, but if it isn’t it will get worse before it gets better regardless of what happens with NG.

      • PF – ‘A dollar tax deduction is a dollar tax deduction’

        Well, not when a dollar of capital gain is taxed at half the rate of a dollar of income.

        Negative gearing is financial alchemy, turning income into capital. Our problem is that we allow a very generous measure of income into the alchemical process (ie no quaratining), and then we tax the transmuted income lightly.

      • chrism – yes the 50% CGT is a bit of a lurk, but that also applies to all investments, not just housing, as does NG of course.

        As a tax matter, it really is a separate issue. Marginal tax rates skyrocket when you sell property for a profit, so carrying forward losses matters. Clearly the net effect varies according to the individual situation.

    • The Patrician

      PF – “It will only be a concern to lazy uninformed investors”
      Yeah, those 1.25m lazy uninformed
      investors.

      PF – “it’s a bit of a non-issue at the moment”
      Yeah, it’s not like the govt needs that $5b a year in revenue.

      • Pat – I haven’t checked but I’ll wager that it’s far less than $5B this year and it would still get claimed next year, or the year after, or the year after.

        Sorry Pat, but accounting is accounting.

  2. I reckon that if they did scrape NG there would be a ton of properties that would go up for sale. I believe it would drop housing prices……

  3. Not sure they would grandfather present arrangements. They might well limit the interest deduction to the rental income generated by the property and all depreciation and other costs as an offset to future capital gains from that particular property. No drain to taxpayers simple.

  4. Hard to tell if Lomas’s flawed critique comes from genuine confusion or a deliberate attempt to scare the confused.

    Either way, to help avoid confusion let’s be clear that the debates not about ‘abolishing negative gearing’, although that’s become a bit of shorthand in some of the debate.

    Rather, we need to change the tax treatment of negative gearing.

    If a landlord wants to blow a part of their non-rental income paying interest for a property that brings in rather less in rent, they should be able to go right ahead (as they currently do).

    But they should not be able to go to the ATO and be taxed as if they never received this blown bit of income.

  5. A lot of those that are trying to protect negative gearing use the ‘interest rates are normal deductions’ argument.

    The fact is that the role of debt and equity and the use of tax deductions for interest is in constant flux. Tax deductions for interest was the great tax perk of the 80s and lead to a whole raft of structures that put all the economic ownership in debt.

    Revenue authorities around the world are still putting the final touches on the catch-up to this. Just quarantining interest losses is only part of the journey – debt equity restrictions on how much interest can be quarantined should be on the table as well.

    • thomickersMEMBER

      correct on your argument and with your posts above.

      I will just add one of my golden rules of investing:

      -tax deductions should never be the cause for your decision to invest.

      In the case of negative gearing into property, the investor has received a tax deduction but they have bought an asset with medium volatility/low liquidity and amplified the risk/return scenario to something that is so much higher than shares fully purchased with “saved money”.

      In the end, aggressive property investors will find out that they received a tax deduction…for purchasing a debt bomb!

    • The tax law’s wording is that interest deductions are only allowed as long as it is incurred in the process of earning income.

      So, actually, the tax law does not allow deductions where the income will never realistically cover deductions.

      It is only via government intervention that the ATO allows negative gearing on loss making properties.

      • That’s a good point Ll. Really for most of the negative gearers the intent is actually to speculate on price and use the NG to shelter other PAYG income.

        The ATO generally would not let this through but there clearly has been political pressure to go soft of M&D speculators.

  6. How can someone like Ms Lomas get away with peddling such blatant untruths? I can not understand how people can claim losses against personal income where for most other types of incomes losses are quarantined to the entity which earnt it.

    Sorry if I have missed this if it has been done already, however a cost benefit analysis of NG against the proper investment of the money the government returns in extra deductions from personal income would be great to see. I think it is time.

    I have to disclose that I do not like the “untouchable” place property has been given in the Australian psyche, so I am biased, however I believe that true growth and income comes from a nation that develops minds that create and develop new technologies and then funds the step prior to commercialisation, so that the nation doesn’t miss out on the life-cycle gains of the discoveries that are successful. There is a significant trickle down effect in the training of not only university educated but also trade related persons, that continues. It feeds on its self, which means giving back money to people making losses on existing assets that create benefits to a microcosm of the economy is just plain daft.

    • reusachtigeMEMBER

      Nah, it needs to go altogether (well, quarantined against the income earning asset only and not other income), but maybe this is a step along the way.

      • It does but it is a good way of building a bridge or a new house in this case to help negatively geared investors off the drip gradually.

    • Once there is sufficient new housing, property prices should fall and incentive to negative gear should automatically disappear over time.

      • Not really. It’s not a matter of sufficient housing. Prices are driven by preferences. Living close to work, schools, recreation, friends is worth more money. Enough housing is unlikely to mean enough in the right locations.
        Some non industry estimates showed a housing surplus a couple of years ago, not a shortage.

        Prices will fall once the speculators are driven out of the market. As long as people can make big gains on land value increases they will drive up prices for everyone else no matter if there are enough houses or not.

  7. I don’t mind the concept of a person negative gearing a newly built house or two as part of an investment portfolio, but when people have 10-12 houses it seems a bit much. Especially as they are usually the landlords who do nothing to maintain the house what so ever.

  8. BubbleyMEMBER

    The politicians are too scared to remove NG because of “what happened last time”

    I personally think they should reduced the NG properties to one per person and household/financial couple or to only to new builds.

    This would reduce the voter backlash the pollies are so terrified of and be a way of slowly reducing investors reliance on NG.

    It’ll never happen but its a nice idea.

  9. JacksonMEMBER

    I don’t agree with commenteurs saying that NG will never be abolished – just have a look at where the discussion is now, compared to even 5 years ago. The “new media” is a very powerful force, it is much harder to hide vested interests and far easier to expose the reality.

    Pretty soon NG will be seen for what it is, if not by the government then by specuvestors fleeing for the exit as they actually realise what they’ve been sold.

    • The problem is that people like us are discussing it, but not the politicians – for them it is a taboo subject.

      As for specufestors fleeing the market – that won’t happen unless the government does start discussing the possibility of removing NG. In the meantime, they’re milking it for all its worth.

    • Agree. The sheer cost & inefficiency of it is ridiculous. It has not achieved its goal (supply side).

      Anyone buying now should do so with the expectation that NG will be removed. Probably not in the next year or two, and maybe not 10+ years, but it is inevitable.

      If Lomas reckons NG removal would trigger a crash – and she understands it will probably be removed – I wonder if she is still screaming “Buy, Buy, Buy!!” ….??

  10. The idea that removal of NG would trigger a mass sell-off of property kind of proves the point that she (and her other property spruiking mates) know that the “investment” aspect of investment property is an oxymoron.

    Sorry people, if NG is the basis for your investment, you’re a fool.

    And the claim that 600k would all of a sudden find themselves homeless…. Oh that’s right, cause it’s going to make even MORE sense for landlords to carry the loss if they have to carry 100% of the expense.

    And “probably most of them would sell”….well presuming they do sell, they will be bought by someone else.

    This is a very feeble attempt to push that barrow of yours, Lomas

    • Lighter Fluid

      I wonder if she meant that the 600k that would end up homeless were the rentiers, not the renters? 😉

      Hilarious nonetheless.

      • Actually, given the proportion of NG’ers below the $80k ATI that could be right….

        I come across quite a few who could legitimately say they’re under “mortgage stress”, yet they are forking out more servicing the debt on a shoddy $500K IP that they bought with the expectation of it doubling in value every 7 years. Still, better to end the misery (so they can start again, rebuild) than drag the disappointment out over the next 20+ years

        You can bet that most don’t take kindly to being told to sell it, bank the loss, and move on…

      • JacksonMEMBER

        IW, most don’t take kindly to being told to sell it

        My experience is there are plenty of people out there telling you to buy, but pretty much no-one telling you when to sell. This goes for every kind of investment, it is totally asymetric.

        The only person telling you to sell is the little voice inside your head that keeps you up at night (if you’re lucky), or the courts (if you’re not).