Big budget bucks down the property drainpipe

Negative gearing is the most sacred of cows among Australian tax concessions. But it’s an immense budget drain, encourages loss-making behaviour and has failed to dent housing shortages.

Let’s assume, despite the evidence, we do have a “budget emergency”. No one doubts the budget needs to be rebuilt over the economic cycle, but let’s assume for now we need urgent, drastic action to fix the crisis. Where to start?
 
Politicians have an array of tools at their disposal. Most of us agree that extensive borrowing right now is simply kicking the can down the road. So park that idea. Although public services are stretched, spending cuts would help the fiscal position. But even the strongest advocates of public service cuts in the Coalition are reluctant to be too specific about them for fear of political backlash.
 
That leaves tax increases, which are also a political no-go zone for both sides (excepting Tony Abbott’s parental leave levy which is offset with a company tax cut).
 
After that there’s just one tool to fix the budget, and that’s tightening up on tax concessions. For there are surprisingly few people or companies who pay their legislated marginal tax rate. In office, Labor has tightened access to some of these, notably the private health insurance rebate and the superannuation tax concession.
 
But there is one concession that remains inviolable, our most sacred of cows – negative gearing. In the face of a budget emergency, negative gearing has warranted barely a peep in the election campaign.
 
If there were truly a budget emergency, and governments were truly serious about fixing it, negative gearing would be amongst the best places to start. Bank of America economist Saul Eslake describes it as “a system that rewards people for losing money” and says that removing it would be close to the top of his policy agenda.
 
So what are the policy arguments for and against negative gearing? The argument for negative gearing can be simply summarised: we allow investors to deduct the carrying cost of investments for other asset classes, so why not for investment property? If we treat investment property differently, we distort the allocation of capital across the economy.
 
Unfortunately, the facts don’t bear this argument out. As Eslake’s quote suggests, most people use negative gearing to run property at a loss in order to reduce their recurrent tax liabilities. The primary objective is not to invest in a productive asset that will generate a positive cash flow, which is the intent of the tax credit, but to minimise an investor’s tax payable on other income sources.
 
According to Treasury, the cost of this concession is around $30 billion each year. This makes negative gearing the single biggest concession in the budget (superannuation is a close second). The size of this concession, or ‘tax expenditure’ is equivalent to the entire forecast budget deficit for 2013-14. In simple terms, if we removed negative gearing, our ‘budget emergency’ would rapidly disappear.

Another strong argument against negative gearing is that it is highly regressive – it disproportionately benefits richer households relative to poor ones. Nearly 40 per cent of households in the top income quintile access negative gearing, compared to less than 5 per cent in the bottom quintile. This means the average top-quintile household enjoys a concession of over $70 per week, while the average bottom-quintile household sees less than $10.
 
Finally, despite the incentive it offers property investors, negative gearing has been unable to remove a chronic shortage of housing supply. So it costs Treasury a proverbial bomb, encourages loss-making behaviour, is highly regressive, and has failed to dent housing shortages.
 
Given this, why are politicians so reluctant to tackle it? It’s because the use of negative gearing has become so widespread that attempts to tackle it unleash a storm of criticism in the electorate, particularly amongst wealthier voters who can exercise political voice.
 
When Paul Keating abolished negative gearing in 1985, he faced a concerted campaign of opposition that ultimately forced him to restore it two years later. As Ken Henry was preparing his tax review that chose not to oppose the concession, he told journalists he still bore the scars of that 1980s experience.
 
Is there another way? It’s certain we won’t see any action against negative gearing in a new Abbott government (or a returned Rudd one), but here’s an idea to put in the drawer.
 
Why not limit negative gearing to new-build housing only from now on? All current entitlements would be grandfathered, so no existing investors would be affected. But for any new investor to access the concession, they must be building new dwellings which address the country’s housing shortage, rather than flipping old apartments on the Gold Coast.
 
It mightn’t be the wholesale abolition of negative gearing that would be demanded by a budget emergency, but it’d be a start.

David Hetherington is the executive director of Per Capita, a progressive think tank.

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