Let's get negative about negative gearing

Negative gearing should be on the Coalition's long-term chopping block. Easing out the costly housing distortion could save $5 billion in structural deficit and maybe, if properly explained, win back a vote or two.

Given the early walloping the Abbott government has taken in the polls thanks to its ‘stop the votes’ policy, the Coalition is going to have to find some good news to win back voters (Abbott’s plan to ‘stop the votes’ is working, November 21).

And given that its mandate is, essentially, ‘undo everything Labor did’, it would be wise to dream up a few positive reforms of its own to take to the 2016 election.

It can't mail out cheques to voters as John Howard did, or grant hefty tax cuts as Peter Costello did while drunk on the revenue surge of mining boom mark-I.

In fact, it'll be lucky to have delivered even one tiny surplus in the federal budget.

So what to do? A root and branch review of the tax system won't produce any joy, will it?

Actually, it could. The federal budget is in crisis on the revenue side, and one of the unexamined holes in the budget is the $5 billion a year used to fund negative-gearing tax concessions.

"Whoa!" I hear you say. "That's too hot to touch!"

Well yes and no. When the various groups affected by negative gearing are seen clearly, political opportunities in this difficult area of tax reform become apparent. But first, the changing nature of our housing market must be understood.

Australians love to own their own homes, unlike many of our European cousins who are happy to rent the same dwelling for years, or even generations.

It's a difficult idea to adjust to, but just who owns a property is not very important. What matters is the security and autonomy of the resident. Germans, 60 per cent of whom are renters, have long-term leases and protections against capricious landlords.

As a result, and unlike younger Australians, they don't spend large amounts of time wondering 'how to get into the market'. They pay their rent, and invest their savings in whatever asset class is offering the best returns (possibly including housing).

There have been two major long-term structural shifts in Australia recently that are making us more German.

The first is a maturing (or over-maturing) of the industry that finances our houses. From around 2000 to the present day, the real price of houses in Australia has doubled, which means effectively that people will borrow twice as much in real terms to buy them.

Put another way, we don't earn twice as much but are happy to set aside twice as much of our earnings to pay for housing. Those hoping for extended gains, henceforth, in house prices relative to incomes are forgetting that we have pushed buyers and renters virtually to the limit.

The finance industry, that wasn't lending nearly hard enough, has now done its job and we're at the outer limits of how much debt we are prepared to service.

And that is leading us to become more German. First-home buyers are walking away from the market and resigning themselves to a long-term future as renters. Around 25 per cent of Australian homes are rented, compared to 60 per cent in the land of lederhosen. 

So there's a lot further for that trend to go.

Over time, it's likely that the 25 per cent figure will go higher. The first political selling point for a reform to negative gearing is, therefore, for the government to say it doesn't want to go as high as Germany.

That's an entirely irrational position – as noted above, Australians place too much importance on who owns a dwelling – but then we can't all be as rational as the Germans. And voters would cheer.

At present, there is a financial anomaly created by negative gearing. The sale-price of dwellings is higher than it should be, as investors bid up prices knowing they'll get a large tax write-off by renting them out. And rents, as a consequence, are lower than they should be.

Proposing to scrap negative gearing sometime in the future – most likely removing it in a tapered way – would avoid a tax shock for older investors, but start to bring rents and sale-prices back into kilter.

That does not mean the rental sector would stop increasing as a proportion of dwellings, but it would not grow as quickly as at present.

But there is a second enormous selling point that could be used to get voters on-side. At present, negative gearing is dramatically skewing the tax system in a largely invisible way. The politician that makes it visible could become a reformer, and a popular reformer at that.

To make it visible, let's take the example of two hypothetical youngsters, Bill and Tony.

Bills' parents choose, at age 50, to buy an investment flat. Tony's parents instead spend their money travelling around Australia to watch their son compete in triathlons.

Bill's parents rent out their flat at a small loss (playing their part in pushing rental prices down across the economy) and are refunded 45c by the tax office for each dollar lost. Meanwhile they accrue capital gains and, long term, have a lovely nest egg to bequeath to Bill, partly funded by other tax payers.

Tony's parents, meanwhile, pay 45 cents in the dollar on their income and spend the rest on 'consumption' that keeps many businesses thriving. For example, they spend a fair bit on Speedos every Christmas time ("He does go through them!").

If the transfer of wealth between these two families (Tony's parents subsidise the investment made by Bill's parents) led to a greater supply of housing stock, it might seem worthwhile. But it doesn't.

The only effect of negative gearing today is to push an increasing proportion of housing stock into the hands of older Australians, and force more young Australians to rent at subsidised prices.

The great inequity begins when Bill and Tony's parents pass on – Bill gets a capital-gains-tax-free windfall that Tony's parents' taxes helped create.

All that is required for the Coalition to benefit electorally from this tangled tax situation is to:

(a) promise to remove negative gearing a point well into the future – taper it away over, say, 15 years; and

(b) to let Australians know that it's a tax arrangement that means some taxpayers are subsidising others in an inequitable way, and that it is forcing more young Australians than is 'natural' to rent for the rest of their lives.

Treasurer Joe Hockey and Finance Minister Mathias Cormann complain constantly about a 'budget crisis'. Reforming negative gearing would remove around $5 billion a year of structural deficit.

And it might even give them a much-needed popularity boost.