Negative gearing has worsened the housing crisis and cost taxpayers billions of dollars: Philip Soos

Few Australian housing policies are more contentious than negative gearing. Despite the publicity it has received and its popularity with government and property investors, little analysis of negative gearing can be found within easy reach, with much of it accessible only in academic journals. Only an occasional fragment is found in the mainstream media.

Australia’s policy on negative gearing is considered a sacred cow by investors and politicians, with Prime Minister Julia Gillard, Treasurer Wayne Swan and Federal Housing and Homelessness Minister Brendan O'Connor ruling out changes to this policy. The reason for this obstinacy is that negative gearing allows a property investor to deduct losses against the investor’s personal income of the investor at their marginal tax rate (MTR), a tax minimisation strategy adopted by 1,110,922 taxpayers who vote. Property is run at a net loss when interest payments and property-related expenses like repairs and maintenance exceed rental income.

The strong Australian economy has not experienced a recession since the early 1990s. This along with reduced personal tax burdens, real rising incomes, extensive property subsidies and tax breaks, and rapid increases in property values, delivered an economic environment conducive to negative gearing. From 1996 to 2010, housing prices surged by 130%, adjusted for inflation and quality.

The present housing and rental affordability crisis is placing tremendous financial stress on many Australians as housing and rental prices have outpaced wages, and provided the spark for the public to question the validity of subsidising investors, whether they choose to gamble on making a return by selling property at a higher price or eventually becoming cash flow positive when rents rise to exceed outgoings.

Despite the fact that negative gearing has existed for a long time, much assertion but surprisingly little evidence has been made to justify this policy across all classes of investment, whether it be shares, business, or property investment. The supporters of negative gearing provide negligible evidence to show that is it a sound policy.

Deductibility and tax minimisation under negative gearing

It is common sense that both businesses and investors should be allowed to deduct the costs directly incurred in making an income, but labour is unable to do so. A salaried employee incurs substantial costs in the course of earning a wage (for instance, accommodation, travelling to and from the workplace, and childcare) but government policy bars deduction of these costs against wages.

There is a double standard in operation here. From a distributional or equity perspective, this policy is biased towards the wealthy, as business and investment capital ownership is concentrated into this class, which relies proportionately less upon wages.

The disparity between wage earners and investors is exacerbated when negative gearing is considered. The net income loss from an investment property reduces the investor’s personal tax liability, even though that loss was generated elsewhere. Earning a wage and earning income from an investment are two separate activities and should be treated as such. Business commentator Alan Kohler accurately summarised the inconsistency between investment and employment:

Five years ago treasurer Peter Costello told Australians: “Work for a living and we’ll tax you at close to 50 cents in the dollar; speculate and we'll only take 25 cents. Not only that but, as a special deal – while stocks last – we’ll pay half your speculating costs.”

To sum up this line of reasoning, investors are unduly advantaged by the present taxation arrangements relative to labor. Investment capital is overwhelmingly concentrated in the wealthiest households, who deduct investments costs against income generated, have the highest personal incomes and thus MTRs, can deduct investment losses against their personal tax liability (negative gearing), can carry forward losses and lower their effective MTRs.

Clearly, the tax system is biased towards the rich in terms of cost deduction and tax liability minimisation. Some of this bias can be reduced by maintaining consistency: labour should be allowed to deduct costs against wages but disallow negative gearing for investors.