Property geared to negative politics

Political reality means the government won't abolish negative gearing anytime soon. But the warm and fuzzy feeling of avoiding tax is causing macroeconomic distortions.

Prime Minister Julia Gillard joined the ABC’s Q&A program Monday night to answer the questions and concerns of everyday ordinary Australians.

Robyn Tracey from the audience asked the prime minister a couple of questions on tax reform, including this one on negative gearing:

"Why hasn’t negative gearing been abolished despite recommendations from the Ken Henry tax review and leading economists in the country?"

It’s a great question.

In April last year, under the headline "Talks test the water on negative gearing change, The Agereported, "The Gillard government has sounded out unions over steps to cool Australia’s housing market, with measures that range from a new sales tax for investors sitting on large property portfolios, to curbing the popular strategy of using negative gearing for multiple properties.”

The Ken Henry Tax Review prepared in 2008/09 had warned elements of our tax could affect macroeconomic stability. The report stated: "The existing tax system is also likely to encourage excessive leveraging in pursuit of tax-preferred income. Where capital inflow is used to finance less productive assets [residential housing], this can also affect long term macroeconomic stability.

"In this regard, recommendations to provide a more neutral tax treatment of savings, to reduce the benefits from negative gearing and eventually abolish stamp duties on housing would also help improve macroeconomic stability.”

The report recommended a more uniform savings income discount be applied across most asset classes to prevent tax distortions created from negative gearing.

In a two day tax forum held in Canberra last October Saul Eslake, an economist with the Grattan Institute, said: "There is no country in the world that allows negative gearing as generously as the Australian tax system does.”

Debate was reignited in April this year by NSW Opposition leader John Robertson. A day later, Treasurer Wayne Swan indicated: "The government has committed to the current arrangements and is not contemplating any changes.”

Reaffirming Treasurer Wayne Swan’s statement on negative gearing earlier this year, Gillard told the Q&A audience:

"For negative gearing we didn’t agree with the Henry Tax review, we ruled that out. We think an abolition of negative gearing would cause distortions to the property market we didn’t want to see.”

It is an interesting comment, considering many economists and tax experts actually believe negative gearing causes the distortions, encouraging property "investors” to leverage up into what is now low yielding, unproductive investments in the pursuit of a favourable tax treatment.

Others believe abolishing negative gearing will cause all the rental accommodation to simply evaporate overnight. On Q&A's Facebook page, one viewer wrote "If you abolish negative gearing millions more will need public housing which the government now relies on investors for. Those on rental assistance won’t have anywhere to live.”

You have to wonder how other countries address this very issue, considering only very small few in the world have adopted negative gearing, including Canada, New Zealand, and of course Australia. Perhaps non-owners in all the countries without negative gearing sleep on park benches at night?

But there could be some substance to what Gillard is saying in the short term. Unfortunately, negative gearing is a legal tax rort in Australia and an immensely popular one at that. According to figures from the Australian Tax Office for the 2009-10 financial year, there are 1,110,922 negatively geared property investors with total losses on investment properties totalling $4.8 billion. (In 2007-08 losses totalled $8.6 billion.)

As Reserve Bank of Australia governor Glenn Stevens said on Friday, the decade up to 2007 was quite "unusual”. Household debt grew at astronomical levels and asset prices such as residential property surged. The likelihood on seeing a similar phenomenon anytime soon is close to zero.

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But as house asset prices surged, rents barely grew faster than inflation. This has created a reasonable deterioration in rental yields. At first, this didn’t faze the property investor as what they lost in yield, they made up for in capital gains. Well that was, until recently. House prices have now been falling for almost a year and a half and there is no end in sight.

The warm and fuzzy feeling of avoiding tax blinds many to the low yields property is currently returning and acts like a slow decaying force field, holding them into the market. Slowly the investor will wake and cut their liabilities, but they won’t all leave at once, en masse.

This is important in the political blame game. Just like the carbon tax is the cause of anything and everything remotely negative happening now, the Gillard government doesn’t want the abolition of negative gearing to be the public cause of the property correction.

In May last year, The Australian reported on a 32-year-old couple selling "because they are frightened the government may abandon negative gearing on investment properties.” According to the article, "The house has been on the market for more than 180 days and, although there have been many viewers, there have been no real offers and the agent has already persuaded them to drop the price by $20,000 to $290,000.” I could be mistaken, but I only heard about the negative gearing debate a month earlier, so either they had a tip-off five months earlier, or this is some political point scoring. It could be July 1985 all over again.

I believe the Gillard government (subject to still being in power), will abolish negative gearing, but not now. They will do it in a couple of years when the time is right and when negative gearing is no longer effective.

Craig Peacock runs a blog called "Who cra$hed the economy?". You can read his posts here.

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