{"id":12973,"date":"2016-03-13T21:40:45","date_gmt":"2016-03-14T01:40:45","guid":{"rendered":"http:\/\/goldstocksforex.com\/?p=12973"},"modified":"2016-03-13T21:40:45","modified_gmt":"2016-03-14T01:40:45","slug":"axe-negative-gearing-for-a-healthier-property-market-saul-eslake","status":"publish","type":"post","link":"https:\/\/thepatientinvestor.com\/index.php\/2016\/03\/13\/axe-negative-gearing-for-a-healthier-property-market-saul-eslake\/","title":{"rendered":"Axe negative gearing for a healthier property market | Saul Eslake"},"content":{"rendered":"

Thanks to Ody for posting this on IC forum. I feel it is worth repeating here because of the current debate around negative gearing.<\/p>\n

Axe negative gearing for a healthier property market
\nApr 25, 2011: Saul Eslake<\/p>\n

The property market would look a lot healthier without it, writes Saul Eslake.
\n—
\nFor almost a quarter of a century, successive Australian governments have, with varying degrees of enthusiasm, sought to promote higher levels of participation in employment, and higher levels of personal saving.<\/p>\n

These are both worthy objectives, ones which public policy should seek to promote. It\u2019s therefore surprising that successive governments have not merely been content to maintain a tax system that taxes income from working and saving at higher rates than those at which it taxes income from borrowing and speculating, but have either increased the extent to which income from borrowing and speculating is treated more favourably by the tax system, or explicitly rejected sensible proposals to balance incentives between the two as Wayne Swan did in May last year when ruling out recommendations made by the Henry Review.<\/p>\n

Under the taxation system, income from working \u2013 that is, wages and salaries \u2013 is taxed at higher marginal rates than any other kind of income: 31.5 per cent for most Australians with full-time jobs (earning between $37,000 and $80,000 a year), 38.5 per cent for those earning over $80,000 a year and 46.5 per cent for those earning over $180,000 a year.<\/p>\n

Income from deposits in banks, building societies and credit unions is taxed at the same marginal rates.<\/p>\n

For those contemplating entering, or re-entering, paid employment (say, after a period of caring for children or aged parents) the impact of tax on income from work can result in effective marginal tax rates of close to, or even over, 60 per cent, on what are quite modest levels of income. The Henry Review concluded that \u201dsome people [are] likely to reduce their level of work as a result\u201d of these very high effective marginal tax rates. This may be one reason why the workforce participation rates of women with children, and older people, are lower here than in other OECD countries.<\/p>\n

By contrast, income from most forms of investment, other than interest-bearing deposits, is typically taxed at lower rates than similar amounts of income derived from working. Income from saving through superannuation funds, and from \u201dgeared\u201d investments (that is, the purchase of assets funded by borrowing) is especially lightly taxed.<\/p>\n

The review calculated that, for a top-rate taxpayer, the real effective marginal tax rates (after taking account of inflation assumed to average 2.5 per cent per annum, and the time at which tax is payable) on income earned from superannuation savings or highly-geared property investments are actually negative, while the real effective marginal tax rate on interest income from deposits can be as high as 80 per cent.<\/p>\n

Very few other \u201dadvanced\u201d economies are as generous in their tax treatment of geared investments as Australia is. In the United States, investors can only deduct interest incurred on borrowings undertaken to purchase property or shares up to the amount of income (dividends or rent) earned in any given financial year; any excess of interest expense over income (as in a \u201dnegatively geared\u201d investment) must be \u201dcarried forward\u201d as a deduction against the capital gains tax payable when the asset is eventually sold.<\/p>\n

In Australia, by contrast, that excess can be deducted against a taxpayer\u2019s other income (such as wages and salaries) thereby reducing the amount of tax otherwise payable on that other income.<\/p>\n

The Howard government\u2019s decision in 1999 to tax capital gains at half the rate applicable to wage and salary income, converted negative gearing from a vehicle allowing taxpayers to defer tax on their wage and salary income (until they sold the property or shares which they had purchased with borrowed money), into one allowing taxpayers to reduce their tax obligations (by, in effect, converting wage and salary income into capital gains taxed at half the normal rate) as well as deferring them.<\/p>\n

As a result, \u201dnegative gearing\u201d has become much more widespread over the past decade, and much more costly in terms of the revenue thereby foregone. In 1998-99, when capital gains were last taxed at the same rate as other types of income (less an allowance for inflation), Australia had 1.3 million tax-paying landlords who in total made a taxable profit of almost $700 million.<\/p>\n

By 2008-09, the latest year for which statistics are available, the number of landlords had risen to just under 1.7 million: but they collectively lost $6.5 billion, largely because the amount they paid out in interest rose almost fourfold (from just over $5 billion to almost $20 billion over this period), while the amount they collected in rent only slightly more than doubled (from $11 billion to $26 billion), as did other (non-interest) expenses. If all of the 1.1 million landlords who in total reported net losses in 2008-09 were in the 38 per cent income tax bracket, their ability to offset those losses against their other taxable income would have cost over $4.3 billion in revenue foregone; if, say, one fifth of them had been in the top tax bracket then the cost to revenue would have been over $4.6 billion.<\/p>\n

This is a pretty large subsidy from people who are working and saving to people who are borrowing and speculating. And it\u2019s hard to think of any worthwhile public policy purpose which is served by it. It certainly does nothing to increase the supply of housing, since the vast majority of landlords buy established properties: 92 per cent of all borrowing by residential property investors over the past decade has been for the purchase of established dwellings, as against 82 per cent of all borrowing by owner-occupiers.<\/p>\n

For that reason, the availability of negative gearing contributes to upward pressure on the prices of established dwellings, and thus diminishes housing affordability for would-be home buyers.<\/p>\n

Supporters of negative gearing argue that its abolition would lead to a \u201dlandlords\u2019 strike\u201d, driving up rents and exacerbating the existing shortage of affordable rental housing. They point to \u201dwhat happened\u201d when the Hawke government abolished negative gearing (only for property investment) in 1986, claiming that it led to a surge in rents, which prompted the reintroduction of negative gearing in 1988.<\/p>\n

This assertion has attained the status of an urban myth. However it\u2019s actually not true. If the abolition of \u201dnegative gearing\u201d had led to a \u201dlandlords\u2019 strike\u201d, then rents should have risen everywhere (since \u201dnegative gearing\u201d had been available everywhere). In fact, rents (as measured in the consumer price index) actually only rose rapidly (at double-digit rates) in Sydney and Perth. And that was because rental vacancy rates were unusually low (in Sydney\u2019s case, barely above 1 per cent) before negative gearing was abolished. In other state capitals (where vacancy rates were higher), growth in rentals was either unchanged or, in Melbourne, actually slowed.<\/p>\n

Notwithstanding this history, suppose that a large number of landlords were to respond to the abolition of negative gearing by selling their properties. That would push down the prices of investment properties, making them more affordable to would-be home buyers, allowing more of them to become home owners, and thereby reducing the demand for rental properties in almost exactly the same proportion as the reduction in the supply of them. It\u2019s actually quite difficult to think of anything that would do more to improve affordability conditions for would-be home buyers than the abolition of \u201dnegative gearing\u201d.<\/p>\n

There\u2019s absolutely no evidence to support the assertion made by proponents of the continued existence of \u201dnegative gearing\u201d that it results in more rental housing being available than would be the case were it to be abolished (even though the Henry Review appears to have swallowed this assertion). Most other \u201dadvanced\u201d economies don\u2019t have \u201dnegative gearing\u201d: yet most other countries have higher rental vacancy rates than Australia does.<\/p>\n

I\u2019m not advocating that \u201dnegative gearing\u201d be abolished for property investments only, as happened between 1986 and 1988. That would be unfair to property investors. Personally, I think negative gearing should be abolished for all investors, so that interest expenses would only be deductible in any given year up to the amount of investment income earned in that year, with any excess \u201dcarried forward\u201d against the ultimate capital gains tax liability. But I\u2019d settle for the review\u2019s recommendation, which was that only 40 per cent of interest (and other expenses) associated with investments be allowed as a deduction, and that capital gains (and other forms of investment income, including interest on deposits) be taxed at 60 per cent (rather than 50 per cent as at present) of the rates applicable to the same amounts of wage and salary income.<\/p>\n

This recommendation would not amount to the abolition of \u201dnegative gearing\u201d; it would just make it less generous. It would be likely, as the review suggested, \u201dto change investor demand towards housing with higher rental yields and longer investment horizons [and] may result in a more stable housing market, as the current incentive for investors to chase large capital gains in housing would be reduced\u201d.<\/p>\n

Sadly, these recommendations were among the 19 that the Treasurer explicitly ruled out when releasing the review last year. That makes it hard to believe that this government (or indeed any alternative government) is serious about increasing the incentives to work and save \u2013 or at least, about doing so without risking the votes of those who borrow and speculate, in effect subsidised by those who don\u2019t, or can\u2019t.<\/p>\n

—
\nSaul Eslake is a Program Director with the Grattan Institute. The views expressed here are his own. <\/p><\/blockquote>\n

Saul’s suggestion of carrying forward losses rather than writing them off against other income is a good one. But I would go a lot further with tax reform:<\/p>\n