Turning a negative into a positive

In terms of the socio-economic development of the nation, negative gearing is, in its current form, a force for unaffordable housing through the pressure it puts on house prices. It is also pushing Australia away from being a land of homeowners and towards being a nation of landlords and tenants. So it is hard to see how any argument that negative gearing is good for the nation’s socio-economic development is tenable.

The argument from its promotion of self-funded retirement definitely has initial appeal. Australia has an aging population that will be an increasing burden on young people through the tax system. Getting those approaching retirement to save and invest as much as possible is, in general, a good way to reduce this burden.

However, negatively geared housing investments are explicitly speculative, mostly economically unproductive, and are aimed at reducing income tax contributions. Any reduction in pension payments as a result of tax avoided is a net no gain at all from a taxpayer perspective.

Further, the speculative gain that negative gearing bets on and encourages is a reduction in housing affordability. Gains in retirement wealth by individuals made from reductions in housing affordability may make them less reliant on pension payments. But what the younger generation saves on taxes for pensions it will pay for in bigger mortgages. Rather than the widely spread tax burden of pensions the load becomes more concentrated on first home buyers.

The concentration of ownership and exposure that negative gearing encourages has two further disadvantages. In a rising market the capital gains are concentrated in the hands of the federally-subsidised, multiple-property-owning few, an inequitable result for any tax break.

While in a falling market the concentration of losses on fewer people increases the chances of bankruptcies due to leveraged losses. This effect combines with the higher mortgages forced on new home buyers by higher house prices to increase tail risk for the economy in the event of a downturn or interest rate spike.

If interest rates returned even briefly to the levels seen in the late 1980’s the economy would not stand a chance with the gearing currently in place on property.

The Reserve Bank suggested to the Productivity Commission Report on First Home Ownership that “the most sensible area to look for moderation of demand [in housing] is among investors” in particular the curtailing of negative gearing and property depreciation allowances. Unfortunately, the Productivity Commission’s final report was a dithering lost opportunity.

The consequence of which is that we have now had five years of unaffordable housing in Australia and the Federal Government is yet to act. A refinement of negative gearing might be a good place to start. If some are truly concerned about benefits of negative gearing in the creation of rental supply housing then perhaps we should look to target negative gearing to cases where it does add to the rental housing stock without cost to owner-occupied housing.

To achieve this we could limit negative gearing to new properties where the building increases the number of dwellings on a block and limit it to a period of five to ten years after construction. Negative gearing would then channel money into productive economic activity.