Debunking the property lobby’s negative gearing myths

By Leith van Onselen

The Property Council and the Real Estate Institute of Australia (REIA) enlisted ACIL Allen Consulting to write a report that attempts to debunk so-called myths that Australia’s negative gearing laws are having a deleterious impact on housing affordability and the Budget, and do nothing to boost housing supply nor improve rental availability and affordability.

The report polishes all the usual arguments. Let’s examine the key ones.

First, the report argues that middle income Australians, rather than high income earners, benefit most from negative gearing:

…negative gearing benefits a range of Australian households by providing all individuals with an opportunity to invest in property, not just those in higher income brackets. Two thirds of property investors who benefit from negative gearing earn a taxable income of less than $80,001 a year. Furthermore, while individuals with incomes higher than $80,001 claim around 42 per cent of the total value of losses on investment property, those earning less than $80,001 a year claim the majority (58 per cent of total value of losses in 2012-13). The data also shows that the majority of investors own only one property and this has not significantly changed over time.

ATO Taxation Statistics show that in 2012-13 there were 1.97 million individuals who owned a rental property, of which around 1.26 million declared a net rental loss.2 Around 67 per cent of those that declare a net rental loss have a taxable income of $80,001 or less.

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The report’s claim is categorically false. Negative gearing is used predominantly by higher income earners.

Taxable income is what is left after legitimate deductions such as negative gearing are accounted for. For example, if someone earning $89,000 a year in 2012-13 claimed the average negative gearing loss of $9,558 that year, then their taxable income would be reduced to $79,442, thus making them appear to be a lower income earner than they actually were, and bringing them within the report’s arbitrary $80,000 threshold.

Moreover, the average taxable income in 2012-13 was only $55,228. Therefore, the paper’s $80,000 threshold for a middle income earner is blatantly mis-leading, since it it nearly 50% above the average taxable income level.

If it was true that middle income earners were the primary users of negative gearing, then we would expect to see the majority of users earn less than the average.

However, the ATO statistics clearly show that 55% of negatively geared investors in 2012-13 earned above the average taxable income level (see next chart).

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The ATO statistics for 2012-13 also shows that the number of negatively geared taxpayers was significantly under-represented at the lower taxable income levels and over-represented at the higher taxable income levels (see next chart).

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The picture gets much worse when the dollar value of losses, rather than the number of users, is examined. As shown in the next chart, those with taxable earnings below the average of $55,228 claimed only $4,645 million, or 39% of the total negative gearing losses in 2012-13, with those earning above average claiming $7,400 million, or 61% of total negative gearing losses:

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Moreover, the breakdown by income range shows that higher taxable income earners claimed an even higher share of the negative gearing losses in 2012-13 (see next chart).

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Therefore, based on the ATO statistics, which understate the magnitude of the issue because negative gearing lowers taxable income, the claim that most people who access negative gearing are middle-income Australians is false. 55% reported earnings above the average taxable income in 2012-13, with their share of losses at 61%, even after their reportable incomes were reduced by more than the average due to negative gearing deductions.

The use of negative gearing also increases with income, and the value of losses claimed even more so.

Next, the report tries to argue that capital gains tax (CGT) concessions also mostly benefit so-called middle income earners:

The 50 per cent discount on capital gains was introduced to eliminate the taxation of nominal gains (see Section 2.3). Eliminating the taxation of nominal gains seeks to provide individual taxpayers with the incentive to invest in order to earn a capital gain and bolster savings and economic growth.

The ATO data for 2012-13 shows that individuals across all income ranges benefit from the CGT discount, with 57.1 per cent of the approximate 389,000 individuals who paid CGT earning a taxable income of less than $80,001.

First, the report’s claim that the 50% discount on CGT “was introduced to eliminate the taxation of nominal gains” is wrong. Prior to the introduction of the 50% discount in 1999, only ‘real’ profits on asset sales were taxed, since they were indexed by changes in the CPI. However, the 50% discount on nominal CGT gains for assets held for more than one year did made the regime far more generous for property investors given Australia’s low inflationary environment.

As for the report’s claim that most CGT concessions are utilised by middle income earners (again, wrongly denoted by those with taxable incomes below $80,000), I have not taken the time to crunch the figures. However, I will leave it to the Australian Treasury to explain why the argument is categorically wrong [my emphasis]:

…the total effective concessions on capital gains income are significant. Both the indexation and discount methods have provided a strong incentive towards financial investment in products which provide significant capital growth, such as shares or property, rather than in products which primarily provide income streams, such as bonds. The concessionary treatment of capital gains income is arguably the primary motivation for financial investment in negatively geared real estate, which aims to shift all of the investment return into the capital gain on the eventual sale of the asset…

Taxable net capital gains income tends to be received by individuals at the higher end of the income distribution. Around half of total taxable net capital gains income reported for 2011-12 was received by taxpayers whose other taxable income was above $180,000 (the top tax rate threshold). For the 2011-12 year the average statutory rate of tax on taxable net capital gains income was 30.9 per cent, compared to the overall average rate of around 22.2 per cent.

Next, the report tries to counter my claim showing that negative gearing does little to boost actual housing supply, since over 90% of investors purchase existing homes rather than new construction (see below charts).

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Hence, my argument is that negative gearing is merely substituting homes for sale into homes for let. Thus, if negative gearing was abolished, it would not harm overall rental availability and affordability since investment properties sold by investors would be purchased by renters (or other investors). In turn, these renters would become owner-occupiers, thereby reducing the demand for rental properties, and leaving the rental supply-demand balance (and rents) unchanged.

To counter this claim, the report resorts to the ultimate in statistical trickery by trying to assert that negative gearing has driven a more than seven-fold increase in investment in new construction:

While the proportion of loans for investors towards the construction of new housing has remained relatively constant at around 30 per cent over the last 30 years or so, the absolute amount of investor loans committed to new housing has increased over time. In 1986, total investor loans for the construction of new housing were approximately $1 billion; this amount increased by more than seven-fold to $7.3 billion by 2014 (see Figure 10).

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Many of these property investors would have made the decision to invest in rental property (regardless of new or established) reflecting many factors including the ability to deduct net rental losses made on their investment. Had negative gearing not been available, it is almost certain that total investment in property, regardless of whether new or established, would have been lower. Investment loans for new housing grew at a significant rate after the reintroduction of negative gearing concessions in late 1987.

A more than seven-fold increase in the nominal dollar value of housing construction by investors sounds impressive until it is compared against the other forms of housing finance (see next chart).

ScreenHunter_8012 Jun. 29 07.21

That’s right. Since negative gearing was reinstated in 1987, the value of loans to investors in new construction has been dwarfed by loans to investors in existing dwellings. Even worse, they have also lagged the overall value of housing finance commitments (ex-refinancings), as well as owner-occupied investment in new construction (see next chart).

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Given the above facts, it is highly misleading to claim that negative gearing has encouraged new construction when every other form of finance has grown even stronger since negative gearing was reinstated in 1987.

And given this false claim, the report’s conclusion that rents would lift by up to $10,000 if negative gearing was abolished makes absolutely no sense, given it does not support housing supply.

The claim is also not supported by historical experience. When negative gearing was temporarily quarantined between 1985 and 1987, there was no discernible impact on rents, with rental growth nationally higher both before and after negative gearing’s removal (shown in red):

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To make matters worse, the report then contradictorily tries to argue that restricting negative gearing to newly constructed dwellings, as flagged by the ALP, would actually make the supply situation even worse and force-up rents:

… limiting negative gearing and the 50 per cent CGT to new dwellings would be a negative shock to the market which would likely result in upward pressure in prices. It is also possible that property investment would be skewed to outer suburbs where employment opportunities are scarce and where transport infrastructure is poor…It is likely that there would not be sufficient new dwellings to soak up a shift in investor demand towards new dwellings, which indicates that the measure would encourage many investors to exit the rental property market…

In addition, the policy measure would pit a large number of investors against aspirant owner occupiers in the relatively small new dwelling market…

Given these factors, the proposed tax change is likely to impose upwards pressure on the prices for new dwellings…

It is notable that there would likely be significant community unhappiness if there was a widespread and enduring displacement of the opportunity for first home buyers to actually own a new dwelling as a result of the proposed policy reform…

In summary, removing negative gearing and the 50 per cent discount on CGT for investment in existing residential property would probably increase investor demand for new dwellings, displace owner occupier buyers and stall further investment in established dwellings. If new housing supply is weak, higher rents and higher new dwelling prices would be expected…

Limiting negative gearing and the 50 per cent discount on CGT to new dwellings would be bad policy. It risks stalling investment in existing property and higher rents.

Seriously, you cannot make this stuff up. After wrongly arguing that negative gearing has boosted new construction and pushed down rents, the report then tries to argue against targeting negative gearing at new construction because it would stall overall housing supply and push-up rents and prices, whilst also locking-out first home buyers (as if the existing laws are not doing this already!). Talk about one almighty contradiction.

The report then tries to debunk the claim that negative gearing and the CGT discount encourages unproductive investment into housing, arguing instead that housing is just as productive as anything else:

…housing is about much more than just bricks and mortar. It satisfies the essential human need for shelter, security and privacy…

Housing is also a significant part of the national economy and an important source of employment…

…housing is the major source of wealth for Australian households. Housing serves two important functions for households: it acts as a savings and wealth-building vehicle for owner occupiers and investors, and it produces a flow of housing services that households consume.

The value of housing services can be directly quantified by rental yields for investor properties and imputed rent for owner-occupied dwellings. If the value of property assets did not appreciate over time to produce a cash return, then it would be correct to label them ‘unproductive’. However, the reality is that many residential assets do earn a real rate of return in the long-run…

Housing is a productive asset. It serves the valuable purpose of providing shelter to people, acts as a savings and wealth building vehicle for owner occupiers and investors, and produces a flow of housing services that households consume.

The report has clearly confused the positive return to home owners from economic rents with genuine productive investment that improves the competitive position of the economy and improves overall living standards.

Additions to the housing stock are productive in that they provide additional shelter to the community. But when capital flows predominantly into existing housing, as has been the case with negative gearing, then it is unproductive investment.

Here’s a question for ACIL Allen Consulting: If Australian housing values were to double due to a sudden flood of capital into housing, would this make Australia more productive? Similarly, if Australian house prices were instead half their current value (and household debt was materially lower), would Australia be less productive? Of course not.

In fact, one could credibly argue that the diversion of bank loans and capital into housing (see next chart) has starved businesses of funds, damaging the nation’s productivity.

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The banks’ heavy offshore borrowings, which have been used to pump housing, have also dramatically increased Australia’s net foreign debt, which is also a drain on the nation’s resources.

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The same could be said about the escalation of land costs across Australia, which has unambiguously lowered productivity, due to the deleterious housing policies (including negative gearing and CGT discount) run by Australia’s various levels of government.

Finally, the claim that negative gearing and the CGT discount “acts as a savings and wealth-building vehicle for owner occupiers and investors” is not credible when an economy-wide view is taken.

Blind Freddy can see that all negative gearing and the CGT discount are doing is using taxpayer subsidies to push-up house prices (see next chart) and turn would-be home owners into renters – hardly a desirable outcome from a budgetary or social perspective.

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Clearly, ACIL Allen Consulting also does not care about the financial security of young Australians who are being locked-out of the housing market due to the orgy of investor participation (see next chart), or are being forced to undergo a lifetime of debt servitude.

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If negative gearing and the CGT discount were unwound, there would be less pressure on house prices and younger Australians would not need to devote as much of their lifetime’s earnings to pay-off a home.

Surely, the financial situation of ordinary Australians would be improved materially if they were not required to pay-off some of the world’s biggest mortgages, due in part to egregious policies like negative gearing and the CGT discount?

Overall, the ACIL Allen Consulting report fails on every level to make the case for retaining negative gearing and the CGT discount.

It should be ignored by all and sundry.

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Comments

  1. Keep up the facts, and record the names of these liars to replay on the credits wall after the Australian Property Bubble horror movie ends.

    • Better still, keep up the facts and put them out there in the mainstream media – radio, TV and newspapers. UE’s articles are too good to be “wasted” on the already converted.

  2. Wow, this fever-pitch squealing must be because the nipples are locked into the clamps and they can see that them clamps are about to be tightened.

    Two options – scare everyone away from tightening the clamps or pay off the right people (politician$) to avoid tightening. The first one is the cheaper option, so they’re going with that. Next step will involve paper bags & will be expensive, but will probably work.

    • Liječnikkretenu

      Maybe Australians should petition Village Roadshow instead to influence policy with the idea of greater household formation leading to more rents.

  3. flyingfoxMEMBER

    Ken Morrison tried to vigorously defend the new build stats on Twitter but I don’t think he had an idea of the statistics in the report actually were or he was very good at appearing so.

  4. My guess is that a picture of you writing that piece would show a large, bloodied bruise in the middle of your forehead, covered in brick dust……

      • macrofishMEMBER

        I amazed you dobt just have a bot/script that complies a response based of existing articles.

      • DrBob127MEMBER

        I can understand your fatigue, but fight the good fight Leith. They stack up the nonsense and you knock it down.

      • Have suggested this several times.
        ==
        You still don’t have a landing page for this. A TL;DR version, infographic, image pack, pre-written bits of text pre-formatted in markdown or html for CMSs. Make the journo/bloggers’ jobs easy.

        We’re talking 2 hrs work here.

        And a sweet landing page. Google juice. Subscribers. $.

  5. This needs to hit the MSM, pick a good journo, send it to him, and tell him to quote you as many times as he likes.

  6. The Patrician

    “..limiting negative gearing and the 50 per cent CGT to new dwellings would be a negative shock to the market which would likely result in upward pressure in prices”
    This is new.
    …and an unsubstantiated lie

  7. Economic consulting outfit writes a bullsh!t report advocating client interests. What a shock!
    Times must be tough for this one, taking on a REIA job. I imagine the folks at ACIL Allen’s had to hold their noses while they wrote the report. Wouldn’t it be good if they regulated the economics profession somehow?

  8. The Patrician

    “..limiting negative gearing and the 50 per cent CGT to new dwellings would be a negative shock to the market which would likely result in upward pressure in prices”
    This is new…
    …taking the lie to a whole new level of nonsense.
    Effectively claiming that increasing the housing stock/supply will increase prices
    What an astounding claim.
    Where is the evidence?
    Where is the data?
    Black is white
    Up is down
    Because I say so.

  9. Questions: How many public servants in Canberra ie those senior types closest to the pollies would earn more than $80,000pa ?
    How many of them own IP’s?

    I know the IP owning habits of the politicians have been highlighted but the PS Mandarins and upper echelons are likely to be snout deep into the trough. Picture Sir Humphrey arguing for NG 🙂

    • Public servants in Canberra earning around $80K are at the most junior levels and go nowhere near the pollies. Bottom level senior executives earn around $180K+ and still wouldn’t hang around with politicians all that often, and the ones who hang around with politicians (ie SES Band 3) earn around $300K+.

      And heaps of them own investment properties.

  10. seriously… these guys are REAL ESTATE AGENTS… they lie for a living! How can anyone ever expect them to tell the truth about anything?

    hopefully posts like those provided above by MB are show writ large on garbage sites like Aus Prop Forum. Us readers on MB all believe the truth about NG, the challenge and reward lies with convincing those spruiks that have all drunk the coolaide.

  11. flyingfoxMEMBER

    One aspect that has not received much attention is that with the CGT discount and NG, only the book value of the property has to change to get an asymmetrical payback (i.e tax loophole). If CPI and price increases are = 0% and the property does have depreciation, you get back half of the depreciation amount as CGT discount. BIG LOOPHOLE!

  12. You still don’t have a landing page for this. a TL;DR version, infographic, image pack, pre-written bits of text pre-formatted in markdown or html for CMSs. Make the journo/bloggers’ jobs easy.

    We’re talking 2 hrs work here.

    And a sweet landing page. Google juice. Subscribers. $.

  13. SoMPLSBoyMEMBER

    Good Grief!

    Should be named the Van Allen Belt Consulting they are so far out in space!

    “..negative gearing benefits a range of Australian households by providing all individuals with an opportunity to invest in property (means: opportunity to become hopelessly addicted to debt).”

    Note: Housing Finance Commitments- above

    All that ‘money’, created with a Mont Blanc, is what drives the REIA and its affiliates, the banks and politicians who also pushed that syringe into the nation’s vein and closed their eyes in ecstasy while applying thumb force to the plunger. ‘Safe as houses’ means ‘safe injection houses’ for a chemically dependent nation.

  14. This is a multi-layered problem.

    First Layer – The losers. These are the late adopters, the poor, those without family capital etc.

    Second Layer – The Speculators and early adopters – prima facie winners. These are the early adopters that are taking advantage of the asset price and rentseeking opportunities. (heavily entrenched in politicians and public servants)

    Third Layer – platform providers. This is essentially the financial providers that provide the mechanism for the battle in Layers 1 and 2, and take a risk-free % of all capital movement. Changes in Layers 1 & 2 only change equality, there is no productive outcome, and as time passes Layer 2 results in more concentrated ownership and more socialised losses and a greater transfer to Layer 3.

    Will Australians get their heads around this? Maybe, the presence of foreign capital in setting price margins is a spanner in the model that may have been underestimated. Still until Australians wake up that house price speculation has more losers than winners then the dream (and reality) of unearned property riches will propel things ever onward.

    Most realistic people have long given up looking for change here – occasionally the frustration bubbles up, but change is going to be near impossible. You only have to look at how well funded the party duopoly is by the financial industry to see that change will never be driven from there.

  15. I will continued to insist that a lot of the theoretical confusion regarding recent urban property markets behaviour, is due to decades of elastic supply of land for growth, flipping to inelastic supply due to “compact city” planning policies and other factors that have similar effects.

    Yes, negative gearing would have done no harm at all under the old paradigm – arguably it would have made rental housing slightly cheaper than otherwise, in a housing market that was systemically affordable anyway.

    Population growth also did no harm, it merely resulted in economies of scale in housing production. So did cheap credit and subsidies.

    Upzoning and building denser did result in cheaper housing units, whereas now it just makes the site owner hold out for higher selling prices i.e. site rents are increased, economic rent per housing unit is not decreased at all.

    These and other theoretical confusions are literally turning into the death of once-well-balanced first world economies.

    The old paradigm still exists in enough US cities, for the point to be well and truly proven.

    • Your points have been strong and well made Phil, but the fact is that the form of land release that might offset the speculative behaviour is a political impossibility in many areas. Even though more and more people are recognising that failure to release supply has very little to do with ecology/environment (most of this stuff is mono-crop farmland held by land-bankers) and much more to do with land price controls.

      Really it’s a bit of everything now – supply, speculation and tax incentives. Its a complex, but manageable process. Practically, the challenge faced has more to do with political structures and how lobbying power intersects with the party system than land release issues.

      • AJ, I appreciate the mutual respect that has built up between us. I agree re the political unworkability in this part of the world, of the solutions that still keep many US cities affordable and stable. I would probably agree with you on a workable mixture of policies that would probably help even if affordability and stability were still not quite as good as Texas, Kansas, Indiana, Georgia, etc. In fact I would settle for Australasian 1960’s – 1970’s – 1980’s affordability and stability.

        Land rationing does need to be more generous, but if it is not lassez-faire, it needs to be accompanied by targeted land taxes to break the land bankers. I would even support compulsory acquisition of sites as a racket-breaker. It is sickening how many compact city advocates point to European examples where they do NOT have Anglo property rights and manage to avoid the great gouge by site owners that occurs when you do mix compact city planning with Anglo property rights – the same advocates are usually clueless about how the market for sites actually works, or whose useful idiots they are acting as.

  16. How backwards are things when the property lobby is lobbying against higher rental yields. Even if they are mythical.

  17. It will be interesting to look at the pollies’ pecuniary interests register over time. If and when you see them divesting their investment properties THEN you will know that that negative gearing etc are to be changed.

    Its a massive form of insider trading except the traders make the rules!