Forget trying to curb demand, build more houses

The short- to medium-term impact on the rental market from less generous tax treatment of investment property highlighted by the Henry review could be mitigated to the extent that any fall in prices induces more renters to become owner-occupiers.

However, substitution between investors and owner-occupiers is unlikely to offer much relief in terms of overall housing affordability, especially if there is also a negative supply response.

Public policy should aim to improve incentives for increasing housing supply. While saving via housing is concessionally taxed, this does not mean that there is no tax burden on housing as such.

The tax burden on new housing includes direct levies such as the goods and services tax, stamp duty, land tax and council rates, as well as a variety of indirect taxes on inputs into housing, development and infrastructure levies.

There are also hidden taxes from unnecessarily complex and expensive planning and approval processes.

The Centre for International Economics has estimated that as much as 44 per cent of the price of a new home in Sydney is accounted for by explicit and implicit local, state and federal taxes.

The animus directed against negative gearing is as much an objection to the tax deduction as its supposed implications for housing affordability. Few people seem to object to an investor buying a property outright or having rental income in excess of deductions, making them a net taxpayer in relation to the investment.

Those who negatively gear ultimately rely on taxable capital gains to make up for net losses on rental income incurred over the life of the investment. Unless capital gains exceed borrowing and other costs, negative gearing is a losing investment strategy.

Like all leveraged investments, negative gearing is risky, not a one-way bet. Property investors specialise in bearing risks that many owner-occupiers and renters are either unwilling or unable to take.

Improving housing affordability ultimately depends on building more and cheaper houses, not on suppressing or diverting the demand for housing.