Labor Should Steer Clear of Negative Gearing in Its Quest to Raise Taxes

Commentary

Australia has an acute housing crisis. Mortgage repayments are at record levels of unaffordability, measured by the ability to pay, and the national rental vacancy factor is only 0.8 percent.

Government moves to increase taxes on superannuation and uncertainty over whether they will or will not apply capital gains tax to the family home are likely to make the crisis worse. The government needs to stabilise the situation by affirming that it will not alter any tax arrangements.

While the treasurer has now ruled out imposing a capital gains tax (CGT), he has been silent on another area that Labor has traditionally targeted for adjustment—negative gearing.

The negative gearing rules affect investors, and if they are concerned that they will lose the ability to deduct losses on a rental property from their total income, they will be reticent to invest. The impact of this will be hardest on low-income earners, the treasurer’s core constituency.

Australia has different tax rules for owner-occupiers and investors. The homeowner is the most tax-advantaged.

They generally have a concessional rate of stamp duty when they buy, and when they sell, they are not taxed on any profit. In addition, first-home buyers are given a range of assistance towards deposits and building costs.

They cannot deduct interest payments, as the U.S. homeowner can. They also live rent-free on their own property, giving them the benefit of an imputed rent, which is also not taxed (although it is in some jurisdictions around the world).

First homes are generally leveraged to 80 percent or even higher, meaning that a 20 percent gain in a house price translates into a tax-free doubling of the initial deposit. This is the traditional way Australians get financially established.

For investors, gearing is also an attraction, which they often achieve without an initial deposit by collateralising their existing family home. They have to pay tax on the rent from the property, less any expenses.

If expenses are higher than the rent they can deduct that against other income—this is commonly called negative gearing.

Take Away Negative Gearing, Lose Investors

As the aim of any investment is to become cashflow positive, these deductions will not carry on indefinitely, and when the property is sold, the investor will pay tax on half the increase in the value of the property in CGT.

So the tax system heavily favours the owner-occupier, who has a lot of incentives to outbid the investor. But even so, private leveraged real estate investment is the staple of the rental market with 20 percent of Australian households owning more than one property.

But take the negative gearing away, and it will become less of a staple. This was shown back in 1985 when then-Labor Treasurer Paul Keating abolished negative gearing, only to reinstate it in 1987 after large increases in rent.

The situation now is worse than in 1985. Not only is there a dire shortage of rental properties, but this is about to be exacerbated by an immigration target of 190,000 each year, which will certainly be higher in reality as the international student market is rebooted after COVID.

At the same time, the latest housing figures show a decrease in building starts, which is likely to be made worse by the Reserve Bank of Australia’s expressed intent to increase interest rates.

The public sector cannot, and will not, meet the demand. Public housing is a tiny percentage of Australia’s housing stock, with 418,000 homes housing only 4.2 percent of the population and with a waiting list of 163,000.

Even if the public sector were to step up, it would face many of the same constraints the private sector faces—lack of land for building, cumbersome and slow planning processes, lack of trades, and lack of materials.

Added to that, public sector procurement and building processes are slower and less efficient than the private sector and stipulate the involvement of trade unions, further inflating costs.

Benefits for All

In the past, opponents of negative gearing have argued that it freezes homeowners out of the market and is a drain on government finances.

Both of these arguments are wrong.

The tax advantage, because of the CGT exemption, lies with the homeowner, who also saves on rent.

Government revenues are probably enhanced.

Leverage allows for the building of more houses overall. This increases the taxes paid to governments in stamp duty, land tax, GST, and the company and personal taxes paid by the builders and professionals involved in the process.

It doesn’t actually change the income from the asset in any way, it just allocates it differently. If there are no borrowings, the owner takes all the income and pays a larger amount of tax.

When the investment is leveraged, the income is shared with the lender, who must pay tax on its interest income. It is quite likely that the deduction against the owner’s other income is matched by the tax paid by the financier.

Labor’s last plan to abolish negative gearing, taken to the electorate by Bill Shorten in 2019, still allowed for a deduction for interest costs, but it had to be grandfathered against future income from the asset.

This meant that the gain to the government was really only in the money value of the timing difference as to when the tax benefit accrued to the investor, which is a much smaller deal for the government than the loss of the immediate benefit to the taxpayer.

The negative gearing deduction, which has been around since 1922, can also be said to be equalising the ground between small and large investors.

Corporate entities can easily structure themselves so as to twin income-producing businesses and assets with less profitable ones and cross-subsidise. Why shouldn’t the individual who buys in their own name be able to make the same arrangements without incorporating?

Unless Labor reassures the market, it is wedged between its own key constituents, who will face higher rents and housing shortages as a result, and aspirational voters who are investing to get ahead.

Current treasurer Jim Chalmers wrote his PhD thesis on Paul Keating, who described himself as the “Placido Domingo” of treasurers. Chalmers needs to quickly learn to sing in tune, or Keating’s biographer will never reach Keating’s heights.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.