What is negative gearing and why use it?
In negative gearing, expenses in excess of income can be written off against other income.
To the best of my knowledge, the full cost of capital is accepted as a legitimate expense of conducting any business. Why should it be different when it comes to investing in housing rental property?
Is it because the losses that are accrued in the first few years of investment may ultimately be recouped in the form of capital gains, after paying the required capital gains tax?
It is true that property values tend to rise with inflation. But there may be little profit when inflation is well controlled. Indeed losses are possible in deflationary times.
Expenses and the cost of capital in any new enterprise, including the acquisition of investment property, are greatest in the first year or two. Some 80% of new business ventures fail . Frequently it is for want of sufficient start-up capital. For business in Australia to thrive, the cost of capital must surely remain a valid deduction.
In my opinion the government would be wise to keep incentives to attract investment into rental housing and not into the more profitable commercial and office property sectors. An increase in supply might help peg rental rises and encourage long-term rental agreements.
What is the case for abolishing negative gearing?
Negative gearing is back on the political agenda at least for debate. Amongst the critics of negative gearing are well-respected economists and financial journalists. They argue that the removal of negative gearing policy was in fact working when Paul Keating abolished it in 1987 and that it was only in Sydney and Perth that house rentals rose. (But the problem was not so much the rent rises as reduction in the supply of rental housing.)
Central to their argument is the view that home ownership is becoming unaffordable as speculators enjoying tax-deductibility for their investment loans can easily outbid first home buyers. This may be true in Sydney, Melbourne and South-East Queensland, but how true is it across the whole of regional and rural Australia?
If we want housing to become more affordable in a supply-constrained world – and it’s likely to remain supply-constrained for the considerable future – then we have to try to reduce the demand for housing. Saul Eslake, an economist at Bank of America Merrill Lynch, says one of the best ways to do that is to get rid of negative gearing for new investors.
But would this not simply divert property investment away from rental housing to other sectors and in doing so create a shortage of rental accommodation? The Keating experiment suggests that this is what would again happen.
If successful, forced deflation of house prices might improve affordability for buyers, but a capital loss for sellers.
In locations of highest demand where competitive pressures with a growing array of international buyers are greatest, the removal of negative gearing might not work.
Sydneysiders are still likely to be paying more than $1 million for their homes, and easily able to sell later at still higher prices without the impost of capital gains tax, while the rest of Australia faces a shortage of buyers for their properties
What is the motivation for change?
Is this an altruistic campaign to increase home ownership, and better the lot of the less affluent in society? I doubt it.
More likely it is a search for greater taxation revenue by government to balance the budget as soon as possible?
Some argue that the family home above a reasonable threshold should be subject to capital gains tax. This is a much more common and significant tax minimisation tool than negative gearing I would have thought, but politically unacceptable.
Government should not try to lower expensive house prices to the purse of first home buyers but rather seek to improve the availability and quality of both owner-occupied, and rental housing in cheaper , less prestigious, locations.
Might the Medicine be worse than the Malady?
The motive is less important than whether the perceived problem justifies intervention. Will the measures work? What is the likelihood that there will be unforeseen and/or unintended outcomes to detract from the result, or even create a greater problem?
If you think this is fanciful then just cast your mind back to the GFC. It was a political drive by the Clinton administration to improve housing affordability for the less well-off that led to the issue of high interest rate, risky low doc or no doc home loans, from which the borrowers could walk away. It was at first a bonanza for financiers to spread risk by bundling the sub-prime loans with those of less risk, but as the borrowers defaulted, the financial mayhem spread around the globe.
Senator Nick Minchin in 2007, responding to a question from Senator Bartlett on housing affordability, answered:
Of course, we have had an experiment in the abolition of negative gearing. The previous Labor government for a period abolished negative gearing and it resulted in a disaster for those seeking to rent housing. There was a drought in the availability of rental housing as a direct result. As a result, the previous Labor government reintroduced negative gearing for that very reason. So it is a reminder that you have to be very careful when you start fiddling around with the policy settings in this area.