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How Australia can win from negative gearing reform

Negative gearing and the capital gains tax have contributed to an unprecedented misallocation of capital that has undermined the Australian business sector, increased inequality, and locked younger Australians out of the housing market.

These are bad policies that have had a raft of unintended consequences. Home ownership rates have plummeted over the past two decades across almost every age group. Australia’s $5.9 trillion property market has become increasingly concentrated, creating a nation of landlords and renters.

Housing policy, rather than supporting home ownership and boosting residential construction, has become a tax haven for the wealthy. The policies themselves have become a wealth redistribution vehicle, shifting income and wealth from younger and poorer Australians towards the increasingly wealthy.

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Proponents of negative gearing and the capital gains tax discount argue that reforming the housing market will result in lower prices, higher rents and reduced investment. Federal Treasurer Scott Morrison believes that these reforms will hurt ‘mum and dad’ investors. Other opponents, such as Immigration Minister Peter Dutton, believe that Labor’s proposed reforms will ‘cripple the economy’.

With the exception of Mr Dutton, there are varying degrees of truth to each of these claims. There will be winners and losers from these reforms but the claims by the LNP are built on flimsy foundations.

By comparison, Labor’s housing reforms are sensible and grounded in sound economics and fairness.

Negative gearing benefits the wealthy

Andrew Taylor

Chris Bowen has said Labor’s plan to limit negative gearing to new homes won’t create a new property bubble. Photo: Andrew Taylor

According to the Australian Council of Social Services (ACOSS), more than half of individual taxpayers taking advantage of negative gearing are in the top 10 per cent of income earners (those earning over $100,000 in 2011). Around 30 per cent of beneficiaries earned over $500,000.

Meanwhile, the National Centre for Social and Economic Modelling (NATSEM) estimated that around one-third of benefits from negative gearing accrued to those in the top 10 per cent of income earners. Around half of all benefits were captured by the top 20 per cent of income earners; the bottom half of income earners, by comparison, received just 20 per cent of the benefits.

This should come as little surprise. According to the Reserve Bank of Australia, nearly 80 per cent of investor household debt was held by the top 40 per cent of income earners.

It’s speculation not investment

The economic rationale used to justify these tax concessions is that they encourage additional investment, supporting employment and boosting productivity, but in reality they have become a vehicle for speculation rather than productive investment.

New construction accounted for just 7.1 per cent of total investor loan approvals in 2015. Property investors display a strong preference for established housing, which is understandable given the additional risk involved with purchasing a yet-to-be-constructed property. Unfortunately, Australia’s tax policy doesn’t adequately reward genuine risk-taking.

It wasn’t always this way.

Construction’s share of investor activity sat at 13 per cent in 1999 before the introduction of the CGT discount and around 55 per cent in 1986 prior to the Hawke government’s decision to reinstate unrestricted negative gearing on residential property.

Home building has been a major support for business conditions in the eastern states.

Home building has been a major support for business conditions in the eastern states.

If it wasn’t for foreign investment we would be in the midst of a severe housing shortage. According to the Foreign Investment Review Board (FIRB), foreign investment approvals for Australian real estate reached $25.9 billion in 2013-14 financial year. Foreign investment in new construction was 3.4 times larger than domestic investment.

Uncertainty surrounding rents

Labor’s proposals will be a net positive for new housing construction, will increase home ownership rates, but may put a dampener on the supply of rental property. The latter has been the focus of a relentless campaign from the property lobby, which has focused on the prospect of higher rents.

The truth is we don’t know what will happen to rents because these policies will reduce both the demand for and supply of rental property. The former puts downward pressure on rents; the latter puts upward pressure. The end result is uncertain and depends entirely on how sensitive rents are to shifts in demand and supply.

The good news though is that home ownership will increase, as reduced demand from property investors will allow existing renters to become first homebuyers. If investors decline as a share of the market then logically home ownership must rise – a fact unfortunately missing from the federal government’s doomsday narrative.

Housing affordability and competitiveness

Labor’s proposed reforms mark the first genuine effort to address housing affordability in decades. Plenty of politicians have given lip-service to the issue, while simultaneously dragging their feet. In the process, they have created one of the most overvalued property markets in the world, a product of short-sighted economic policy and greed.

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Young Australians are locked out of the housing market by high prices.

High land prices not only lock many Australians out of the housing market but also undermine the business sector. Overvalued land is often a crippling barrier for many Australian corporations. It hurts shopkeepers and department stores; manufacturing and trade. Any business (with the exception of banks, real estate firms and property developers) that requires a physical location is undermined by high land prices.

On an international stage, where currency and competitiveness is king, Australian firms are often at a distinct disadvantage. High land prices make it difficult to produce at a scale that gets fixed costs down to a competitive level. As a result, many Australian businesses fall short of their potential.

The irony of the current housing debate is that the LNP’s position is actually anti-business. They are happy to undermine Australia’s business and trade performance to reward rent-seeking banks and the property lobby. Meanwhile, the Labor Party is pursuing an agenda that is not only advantageous to millions of Australians but also supports employment and domestic production.

In the short-term there will be winners and losers from housing market reform. In the long-term Australia will be the real winner.

Callam Pickering is a former economist with the Reserve Bank of Australia and economics commentator at Business Spectator. He blogs at cpeconomics and tweets at @CallamPickering

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