Silence on property breeds anxiety

While the RBA continues to voice its concerns about the Melbourne and Sydney property markets, we don't actually know enough about the impact of investor activity because Treasury hasn't done any work on it.

Investors are buying about half the houses and apartments coming on to the market while first-home buyers have been squeezed by high prices to a record low share of just one in eight sales.

The Reserve Bank thinks this is a problem -- investors are buying much more than the rental stock’s one-third share of the housing market. It fears investors are driving up prices at a pace that prefigures a fall, which would be damaging for the broader economy.

The last time investors dominated the real estate market like this, the Reserve Bank argued the tax treatment of investment property was too generous, suggesting there was a case for Treasury to intervene. The Productivity Commission agreed. Then treasurer Peter Costello had asked the commission to investigate what could be done to stop first-home buyers being excluded from the market.

It recommended the government review the tax treatment of investment as a matter of urgency. Costello rejected this out of hand. It was 2004, with an election due, and Costello was proud of his 1999 capital gains tax concessions, which the Productivity Commission suggested were contributing to the problem.

Neither the Productivity Commission nor the RBA blamed negative gearing, although they noted that Australia’s treatment was more generous than that of other countries.

Access to negative gearing deductions is restricted in the US, Canada, France and Germany, and banned altogether in Britain and The Netherlands. Rather, it was the combination of negative gearing with the concessional rate of capital gains tax and the ability to depreciate investment properties (notwithstanding the expectation that their value would go up) that distorted the housing market.

The result is that at least two-thirds of all property investors are looking exclusively for capital gain, with rental income treated merely as a means of defraying some of the cost.

“The general income tax regime has facilitated highly geared housing investment aimed at reducing current taxable income and deferring tax until capital gains are realised in future years. However, just as they have added impetus to the recent boom, so too could these arrangements reinforce any future market downturn,” the commission concluded.

The Reserve Bank noted that in the US only 10 per cent of property investors were aiming primarily for capital gain while in Britain the figure was one-third.

Capital gains concessions and negative gearing allowances apply equally to investment in shares and property (or gold or tulip bulbs). Yet the profile of investment in these two asset classes is wildly different. Because of dividend imputation, shares are held for their income, whereas property, where rent is fully taxed, is highly leveraged and held for capital gain.

Australia’s 2.7 million landlords run their properties worth a total of about $1 trillion at a collective annual loss of about $8 billion. That loss is used to reduce their taxable income from other sources. Tax records show they get $33bn in rent but pay $24bn in interest and another $17bn in expenses. Property investors make their profit when the day comes to sell.

Ken Henry’s tax review tried to bring more sense to the taxation of investment, which varies widely according to whether people put money into shares, bank deposits, rental property or superannuation. The review argued the 50 per cent deduction for capital gains, which is supposed to compensate for inflation, was too generous given the Reserve Bank’s commitment to keeping price growth between 2 and 3 per cent.

It urged that income from rent, interest or capital gains should all be reduced by 40 per cent for tax purposes. The amount of interest that could be claimed as a tax deduction against an investment would also be reduced by 40 per cent.

The effect would be to shift the bias in the tax system away from capital gains and towards the production of income. There would be a tax advantage in receiving rental income, and a smaller tax concession for leveraging property investment. It said this should be phased in across five years.

Former treasurer Wayne Swan rejected the recommendations on capital gains and negative gearing, did nothing with the recommendation on rent and promised a token tax rebate on interest income that was later abandoned. Like every other recommendation from the Henry review, its ideas for investment tax reform turned to dust in Labor’s hands.

It is possible the RBA’s concerns about the Sydney and Melbourne property markets are misplaced. And it may be that the skew of investor focus towards capital gains, which the tax system fosters, does nothing to introduce instability into the Australian housing market. But we do not know because Treasury has done no work on it.

There has been no reference to housing markets in any recent speeches from Treasury, nor any working papers shedding light on their dynamics.

A succession of treasurers has lacked the courage to entertain any change to the tax regime and has been happy to flick responsibility for housing markets to the RBA. Treasury needs to take some ownership of the issue.