Negative gearing: a legal tax rort for rich investors

By Leith van Onselen

If you get a spare five minutes today, make sure you head across to The Guardian to to read Greg Jericho’s ripping dissection of negative gearing, which he proves is nothing more than a legal tax rort that reduces housing affordability:

As the cabinet papers of September 1987 noted, it is “a generally recognised tax shelter”, which is a polite way of saying a legal tax rort…

Those in favour of negative gearing often cite how when the Hawke government did away with it, rent prices shot up…

The real reason for the previous increase in rents in Sydney and Perth was due to “local influences rather than tax measures dominate in metropolitan rental markets”, as found in the 1987 cabinet papers.

At the time, the big local influence on rental prices was vacancy rates. In Sydney and Perth vacancy rates before the removal of negative gearing had fallen sharply, and thus, not surprisingly, rent prices went up as people were desperate to find a place:

ScreenHunter_6667 Mar. 20 08.41

…The Reserve Bank uses data from the Household, Income and Labour Dynamics in Australia Survey. That survey found that in 2010 that the richest 20% of households were much more likely than other households to have an investment property loan:

ScreenHunter_6668 Mar. 20 08.43

…And since 2002 there has been a surge in investors within the richest 20%. In 2002 just 16% of the richest 20% of households had an investment loan, by 2010 it was up to 23%…

And it is a rort. It does not affect rents because it has little impact on the level of housing stock: 92% of investor housing loans are to buy established dwellings…

So it is really just a subsidy for people who are speculating on the real estate market…

A look at rental prices over the past decade shows that rents have actually risen by more than the price of new dwellings purchased by owner occupiers…

So why does negative gearing remain?

Because of the 1.8m investors and the industries behind it…

Laughably, in 1987, the Masters Builders Association suggested that negative gearing “exerted a strong psychological influence on landlords and investors”. Which I guess is a way of saying – don’t bother with the evidence – go with “the vibe”.

And thus it remains.

Seriously, go check the article out. While the arguments against negative gearing are nothing new, there’s loads of charts and some interesting historical information that I hadn’t seen before.

Anyone still arguing for negative gearing on policy grounds must either be stupid or have a clear vested interest (most likely the latter).

 

Unconventional Economist

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

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Comments

  1. flyingfoxMEMBER

    (most likely the latter).

    I don’t know about that. Most likely both from what I have seen…

  2. Negative gearing: a legal tax rort for rich investors – maybe once upon a time, but clearly no longer, every man and his dog are now playing the game… the only difference is that the rich can afford to take the hit when the crash eventuates. And Greg Jericho’s numbers bears that fact out – in that the percentage of households with the largest portion of property loans by age is the 35-44 year age bracket, recently overtaking the 45-54 bracket. And on any reliably measure, if wealth was the major determinant, it should be the other way around (i.e. you typically get more wealthy the older you get). And that matches anecdotal evidence from numerous sources.

    So the title is true in one sense, but actual gives an inaccurate overall picture – either that, or his analysis is a little lacking.

    In either case, when this goes bust, it will be nothing short of brutal. And Gen X will bear the most of the brunt, for borrowing without forethought… being a Gen X myself, it makes intuitive sense, greedy without realism is the hallmark of my generation. And we will reap the reward!!!

    • “So the title is true in one sense, but actual gives an inaccurate overall picture – either that, or his analysis is a little lacking”

      Did you happen to read the article?

      “Last year the ABC’s Michael Janda did some excellent research to bust the myth that it was “mums and dads investors”. The Reserve Bank uses data from the Household, Income and Labour Dynamics in Australia Survey. That survey found that in 2010 that the richest 20% of households were much more likely than other households to have an investment property loan”

      “And since 2002 there has been a surge in investors within the richest 20%. In 2002 just 16% of the richest 20% of households had an investment loan, by 2010 it was up to 23%”

      Young people can earn high incomes too

      • You’d be surprised, Deenominator, at the number of people who comment on the content of articles they haven’t even read.

        Researchtime suggested Jericho’s ‘analysis is a little lacking’. An excellent article well written – but there is always at least one who will digress, unread.

      • Well clearly I read it, both of you – given the data I was referring to is not contained above, but in the original article!

        Dags – which leads me to the question – did you read it?

        And don’t worry – I already know the answer – its NO…

      • So you read the bit where the highest proportion of investors is in the top two income quartiles yet you concluded that it’s not a rort for rich people, because young people are also investing?

        I agree with your comment below that FOMO is pushing young people into the game too, but its overwhelmingly a tax minimisation game for the rich

    • flyingfoxMEMBER

      @RT

      What I suspect that is a result of is young buyers becoming “investors” before home owners to “get on the ladder”. Also for young couples without kids and too much disposable income, it is an effective tax shelter.

      • No… its a gamble, its the fear of losing out… and for that avarice they will burn for it. And blame someone else of course. [probably on this website!!!!]

      • I’m with RT here. It’s a mix for sure but mostly it’s just a big bet on a horse that’s had some good wins.

      • It’s an effective tax shelter, but if the market turns, they are toast.

        It’s a tax shelter for the “rich” whose nominal wealth is based on a bubble.

        RT is spot on.

    • “…the only difference is that the rich can afford to take the hit when the crash eventuates.”

      Rich perhaps, but not necessarily high income earners (and Jericho’s figures are based on income, not wealth). I would suggest that high income earners might tend to be in industries that get hit harder from the crash (e.g. mining, finance, real estate) than lower income earners.

      “And Greg Jericho’s numbers bears that fact out – in that the percentage of households with the largest portion of property loans by age is the 35-44 year age bracket, recently overtaking the 45-54 bracket.

      And on any reliably measure, if wealth was the major determinant, it should be the other way around (i.e. you typically get more wealthy the older you get).”

      Doesn’t the fact that you get wealthier as you get older also mean that you’re more likely to have paid off your property loan?

      • Don’t know exactly – but, anecdotally I suspect not… because people/families typically upgrade their own residences around the age of 45-54, thereby taking on additional debt.

        And total debt figures generally bear this out, that peak debt, peak income and peak spend for families coincide within this grouping (typically around 52 -53 years of age). Debt and spend peaks decline sharply after this point as people look increasingly toward retirement and savings towards that point.

  3. Shouting in an echo chamber won’t help.

    Once the pollies offload their IPs, the economy dips and they get desperate, then there -may- be -some- reform.

    Until then it is equity maaaaate!

  4. Had a chat with my accountant a month ago and she said that tax avoidance is very easy in Australia for HNWI, no need to go offshore, super and NG are available.

  5. SoMPLSBoyMEMBER

    The interest and scrutiny of NG is expanding rapidly despite the T’s efforts to conceal the imperative in keeping this distortion in motion.

    It’s just a matter of time before it is exposed as the ‘nitrous oxide’ performance enhancement of the Big 4 loan book engines.

    “If the camel once gets his nose in the tent, his body will soon follow.”

  6. How can macrobusiness.com.au missed this ?

    Maybe I missed it.

    http://www.abc.net.au/news/2015-03-20/nationals-cross-floor-to-send-message-to-coalition-counterparts/6334014

    “It urged the Senate to condemn “the deliberate restriction of land for new housing and subsequent price gouging by state and territory land management agencies”, and highlight, “the constraints on land supply which are the principal causes of worsening housing affordability”.”

    And of course –

    “It was defeated 48 votes to 10 with most Government senators, Labor and the Greens voting against it.”

  7. Simple, do what the US does. If you earn $150k or more or you are a “real estate professional” (that is, RE investment is what you do for al living), you cannot deduct your mortgage interest on investment properties.

  8. Negative gearing is more than just a tax shelter as well. Thanks to John Howard, capital gains are taxed at concessional rates, so it also allows the conversion of revenue gains (income) into tax effective capital gains.

    Just more of the unfairness between how we tax wealth v work.

    The answer is quite simple. Quarantine interest expense to income from the asset it relates too, and ensure there is no tax differential between capital and revenue at a personal level.

    Is a bit of evidence based policy really that hard. Next the supply side.

    • Aj, whilst I agree with your view that negative gearing should be changed to “neutral gearing” (meaning deductions are limited to the level of property income and are therefore not offsettable against other income), a couple of clarification points;

      1. Putting capital gains aside, there is no financial benefit from negative gearing as such. Negative gearing by definition means the investor is incurring a loss and the government will refund (if you are on the highest tax rate) 47% of that loss, but it’s still a loss. If the sum total of these after tax losses are more than the after tax capital gain when the property is sold, then the investment was loss making. The less sophisticated property investor (and there are plenty of them) often overlooks this

      2. Whilst Howard introduced the capital gains tax discount, prior to that (in the Keating era) capital gains were adjusted for inflation, so if you held a $400K asset for 10 years and CPI was 3%, the tax base would be $540K and you would pay tax at your marginal rate above that. If the property was worth say $700K, under the old method you would pay $78K in capital gains tax if on the 49% MTR. Under the current 50% discount method, the base price would be $400K and you would pay tax at 24.50% of $300K = $74K. Not a great deal of difference. The new method favours shorter investment periods but can result in higher tax on longer investment periods.

      • 1. That’s a pretty simple concept – all but the most silly get that. I suspect what you mean is that most overestimate their capacity to make capital gains sufficient to justify the shelter. It is almost universally common that people over-rate their investment skills.

        2. Yep, and how does that same equation work on a 1mil gain over 4 years. Howard tax changes favoured speculation.

        The main point here is that income tax is being sheltered to provide cash flow for asset speculation. It is simply stupid and should go.

        I would even go further to say that we should consider if debt deductibility should go altogether. All we do these days is take equity and convert it to debt for deductibility where it suits. Financial markets have evolved to the point where there is no substantial difference in debt or equity, particularly by the time it hits P&L and balance sheet of a business.

      • My first point was slightly different but the outcome is the same – some people believe that the tax deduction for a loss on rental fully covers their loss. For example, rental income $20K, expenses $30K, they believe they will get back $10K from the tax office.

        On point 2, that’s technically right, but remember for shorter investment periods, the level of capital gains tax collected is also proportionately higher than the sum total of negative gearing losses during the investment phase. So on your (extreme) example, lets say the starting investment was $1M, rent was $50K pa and deductions $80K pa. Total tax refund $15K assuming the top MTR. Over four years total tax foregone = $60K, capital gains tax collected = $250K plus stamp duty on the original transaction $41K and stamp duty on the sale (paid by the purchaser) $90K. Net tax generated = $321K. If negative gearing encouraged the investor to enter in to this deal then it has been successful in stimulating tax revenue.

        Obviously under the “Keating” method, the gain to the taxpayer would have been higher in your example, however if the property was held for more than say 10 years, which is equally as feasible as the example you gave, it would have been lower.

    • Negative gearing is more than just a tax shelter as well. Thanks to John Howard, capital gains are taxed at concessional rates, so it also allows the conversion of revenue gains (income) into tax effective capital gains.

      NG as a tax shelter is meaningless without significant capital gain.

      Otherwise you’re just losing money to the banks rather than the Government (though thanks to decades of brainwashing, many people believe this is a preferable scenario).

      • Um yeah that’s what a tax shelter is – you get to use the money yourself for a bit longer before it goes to the tax man ie you get a shelter. Of course it’s no point if you don’t use it wisely.

      • To clarify, if cap gains were taxed on parity with income, then the shelter would still be useful because it’s cash flow for the asset holding (speculation) but there is only a timing difference on the tax (assuming you stay at the same income tax rate). (And of course this all assumes you use the shelter wisely -haha)

        Howard’s CGT discount turned this into a permanent difference, so even if the shelter wasn’t that wisely used it was tax effective because it converted heavily taxed income, into concessionally taxed gains. Howard incentivised the speculation further, and he did so pro-cyclically at a time when Greenspan was starting the greatest asset boom the world has ever seen.

      • “Thanks to John Howard” – CGT before Howard allowed a CPI cost base adjustment which resulted in lower CGT than the 50% method over longer investment periods. What you should say is “thanks to Paul Keating and John Howard”.

        The point drsmithy was making is that unless there is a capital gain there is no benefit and there is no guarantee of capital gain. Australian investors do have the mentality that they have “beaten the taxman” even if they make a loss, not realising that it has cost them on an after tax basis.

  9. kinetic ritual

    It is beyond belief that neither major party can see that they are presented with the perfect economic climate in which to remove negative gearing on existing dwellings, and retain it for new builds. There will never be an ideal political environment for them to do so (short of them being dragged onto the scaffold), but economically it has never made more sense.

    Our capacity to become a truly competitive nation of innovation and exporting high value add is being strangled by the obsession with housing. There is no choice but to kill it off, no political way forward for any party until we have killed off the obsession with capital gains in housing.

    Fix the supply side, yes, but for Christ’s sake, as a matter or priority get highly leveraged investor demand for existing dwellings out of the market.

  10. Did anyone else have a look at The Project’s Facebook site after the man, Waleed Aly, got stuck Into negative hearing? The comments section on this issue was very enlightening. It’s seriously like stepping through the looking glass! Whilst there was a mix of views, the negative gearing defenders were pretty aggressive. I wonder if these self-proclaimed high achievers realise the risk they’ve taken on?

      • Mining BoganMEMBER

        Yep, mostly. But I will repeat what I’ve been saying here over the last few days about the venom aimed at anyone who dares to open the conversation we all need to have.

        Our society has let their greed and ignorance build a strong wall of nastiness. It’s going to take something big to defeat that.

    • I know quite a few professionals with more than 2mil in speculative housing debt. Negative gearing is a big cash-flow issue – there’s a bit at stake here for these punters.

  11. At least the money vaguely stays in Australia. Conversely, if I were to propose that we push back against the tax arbitrage that sees low taxed finance centres, Singapore-Hong Kong-tax havens, pulling (would be) capital from Australia, it would be fruitless. Why? Well say we proposed lower tax rates on financing and investing cash flows to address the low rate-finance centre arbitrage, and higher rates on operating cash flow oriented profits, two things would happen:
    1. I’d be crushed by the tax professional community, who would show me that that would involve reform of the OECD model tax convention and about a million double tax agreements, leaving me dead of old age before it was complete. 2. The banks would crush me. SO MY RESPONSE IN A NUTSHELL: There are bigger fish to fry (cross border tax arbitrage) But please HELP on that one because of the reasons outlined!!!!!

  12. This issue will not go away – we have the following reports due in the next 4 weeks……….

    30 March – Latest (and probably will be ignored) Tax White Paper.

    Followed up on 14 April by the much delayed Affordable Housing Inquiry Report http://tinyurl.com/kfqt4ws

  13. The conclusion is correct: it’s a rort, but no one is going to do anything about it. So you have two choices. Get on board and hope nothing derails the party train of increasing prices, or sit on the sidelines and hope it all goes up in flames.

  14. Look out, the new angle coming from judy sloan will likely be rents didn’t rise elsewhere because the timeline wasn’t long enough.

  15. Honestly, just because we don’t like high property prices, doesn’t mean we design a tax system to attack the enemy.

    Personally I’m glad to see as many tax deductions as possible to starve the beast in Canberra. Less warfare and welfare is a better thing.

    • Mining BoganMEMBER

      Except the good-looking out there can’t afford a place without middle-class welfare.

      Oh, what a tangled web…

    • “Personally I’m glad to see as many tax deductions as possible to starve the beast in Canberra. Less warfare and welfare is a better thing.”

      Personally I’d prefer to see far fewer deductions and lower tax rates.

    • If you want to reduce welfare you need to address the structural problem in the economy that cause poverty and unemployment in the first place. Put a stop to the many many rents.
      Unless you are happy to reduce welfare by actually having people die off? Or go back to the good old days where the poor were little more than wage slaves. Cause I guess that would work.

      • You can only reduce poverty by getting rid of welfare which subsidises it.

        This is an economics blog, not a place for people to put forth their religious and ethical views.

      • I don’t believe that it is possible to entirely separate politics from economics. That’s why it used to be called political economy, and I think the attempt to do so is a source of the failings in neoclassical theory.

        But anyway. You say the only way to reduce poverty by getting rid of welfare. I assume there is more to your theory? Simply removing welfare isn’t going to be enogh, what else has to change and how does it work?

  16. Negative Gearing: the more you borrow, the more tax you don’t pay.
    Can’t believe Bubbles McHockey hasn’t thrown this slogan around.

  17. Those people that are buying investment properties thinking this won’t go up in flames, ummm… Please consider the following:

    House prices and debt growth supporting those house prices have been rising at around 10% per year, on average, for 20 years.

    During that same period wage growth averaged around 3% per year.

    The system we currently have is built to fail! We can’t have increasing levels of debt growth that outstrips income growth into perpetuity. It’s an inherently unstable system.

  18. Unfortunately everyone has a vested interest, it’s just that some people don’t understand they do.

    I should state that I don’t own an investment property so in theory I have no vested interest.

    Well, that’s if I don’t consider the State Governments revenue stream as important or the impact it will have on owner occupied houses by removing the marginal buyer, or the knock on effect into banking stability and the downward impact on aggregate demand

    The system is what the system is. Destabilising it with unknown outcomes seems foolish to me as the world battles zero growth and a deflationary spiral.

    People will say oh we are only putting off the inevitable but are we?

    We can barely predict what will happen in the next six months let alone what will happen over 2 to 3 years.

    Besides which, politics will always trump economics and whomever is out of power when this change possibly arrives will simply state they will reinstate it when back in power.

  19. Stupidity and Australia are not mutually exclusive and could reasonably argue that one can’t exist with out the other.