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There's no doubt that Australians invest a disproportionate amount in investment housing, and no doubt also that they would invest less if negative gearing on housing investments were outlawed. Investment in housing would be even lower if the government ended the capital gains tax concession that has halved the capital gains tax payable on housing investments since 1999. Whether investment would actually become better balanced and the economy better off is another thing entirely. Negative gearing — which allows taxpayers to deduct borrowing costs that support an income-producing investment from not only the income the asset generates, but other income including salaries — is popularly associated with housing investment, but it is far more pervasive than that. It applies to almost all geared investments in this country (the major exception is farms), and in an important sense underwrites them, by recognising that investment returns tend to increase over time. In the early years (what companies investing in new businesses call the establishment phase) costs can exceed income, producing a loss. The tax system supports business investors through this period allowing the loss to be deducted from other income. Importantly, the concession cannot be claimed if investors are intentionally setting out to produce losses. If that is occurring, as some claim, there is a problem with the enforcement of the law — and the Tax Office has in fact announced that this year it is cracking down on deductions claimed against rental income. The story is similar with capital gains tax. The halving of the CGT rate in 1999 coincided with a sharp acceleration in housing investment, and in the opinion of the Productivity Commission in its report on housing affordability last year, combined with the negative gearing concession to propel it. There is, however, a particular problem with the lower CGT rate introduced six years ago. The higher CGT rate was aligned with the top marginal tax rate, and that meant that negative gearing deferred tax, but did not avoid it. Negative gearing reduced the investor's tax bill, most often at the top marginal personal tax rate, but the value the deduction created was built into house prices (they rose) — and they were eventually taxed, at the top marginal rate, when the asset changed hands. Now, CGT is half the top marginal rate. This means that only half the gain negative gearing creates is being captured when the asset is sold — and that is why the CGT change has super-charged the housing investment market. Those who propose different, harsher negative gearing or capital gains tax regimes for housing are proposing that the Australian system be deliberately and massively weighted against investment in a single asset class. Several difficult questions would be raised. Where would investors turn to, for example? And what impact would shutting off housing investment have on long term household savings, given that the preponderance of housing investment is in a single home or apartment, and intended to provide a retirement asset and income stream? The complete removal of negative gearing and the imposition of higher CGT would probably not only deflect investment, but deter it. Given the huge importance of the housing sector in this economy, and the political importance attached to home ownership, even second homes, this is a prospect that no government can embrace easily. Less aggressive attacks would aim to more subtly deflect investment and not kill it, and there is a precedent, in Treasurer Peter Costello's 1999 crackdown requiring that individual investors' farm losses can only be written off against farm income. Housing investment losses could be tied in the same way to future housing investment income, and that system is in place elsewhere, including Britain. A realignment of capital gains tax, back up to the top marginal rate as far as housing investment is concerned, would be another option. Even then however, there would be unquantifiable risks. There can be no doubt that investors would switch their attention to other assets if the tax system was altered so that it discriminated against housing investment. Indeed, that would be why the change was made. But the government would have no control over where the migrating investors go. The most obvious, available and welcoming home for the money a crackdown tipped out of housing is, of course, another market that is liable to speculative excess: the sharemarket. THE CASE AGAINST - Tim Colebatch In 1990, 7.5 per cent of Australian taxpayers owned rental property. By 2003, 14.3 per cent were rental landlords. And a very unsuccessful business it was. In 2002-03, 60 per cent of owners told the taxman they had lost money on renting. As a result, they had to write $5 billion off their taxable income. And since half those losses were run up by people facing marginal tax rates of 42 or 47 per cent, that cost revenue close to $2 billion. Put this in perspective. Australia has had 20 years of wrenching policy reforms to make the economy operate on market principles. One of these is that the state should not subsidise commercial activity. The aim of these reforms is to raise Australians' productivity, output and incomes, by ensuring that investment flows where it yields the greatest return — not in subsidies, but through the market. So why is the government encouraging us to make unprofitable investments in rental housing, write off the losses against tax, and then pay only half-tax on capital gains? Those who defend negative gearing hoist the flag of principle. It is a principle of tax policy, they argue, that the costs of commercial activity should be written off against a taxpayer's income, even if the costs exceed the income that activity produces. If rental losses could be written off only against rental income, they argue, this would create a distortion in the tax system, leading to an exodus from property to equities. But that is neither the principle nor the reality. Professor Cameron Rider, director of taxation studies at the University of Melbourne law school, pointed out last year to the Productivity Commission's inquiry into first home ownership, that the tax laws and the High Court agree that net losses can be deducted only where there is reasonable expectation that the investment will yield a net income flow over its life. That was the principle adopted by Treasurer Peter Costello in his 1999 reforms to tax treatment of losses from non-commercial activities. In fact the distortion is that, for political reasons, Costello then exempted investments in rental property and shares from his own law. Tax policy is full of conflicting principles in constant collision. Good tax policy is driven by pragmatic judgement as to where to draw the line. Costello's 1999 reforms, for example, cracked down on the Collins Street farmers by ruling that farm losses could be deducted only against farm income. It was a good call, and one he should now extend to rental losses. Look again at the statistics. In the nine years to 2003, the number of people paying tax rose 13 per cent, but those declaring rental losses grew by 69 per cent. In 2002-03, 10 per cent of taxpayers wrote off rental losses against tax. In nine years, rental costs claimed against tax shot up by 125 per cent, and tax commissioner Michael Carmody says that in 2003-04 they rose almost 20 per cent. Since 2002, loans to investors have almost doubled, interest rates have jumped 125 basis points, while rents have only edged up. You can bet that negative gearing is now costing the rest of us $3-$4 billion a year. The question should be: does this work to boost our economy, or shrink it? The answer is obvious. Would we be better off phasing it out, and using that $3 billion plus to cut tax rates for all taxpayers? The answer is obvious. |
