With not one, but two investment banks warning of a housing price correction next year it would be tempting to argue the ‘market’ is poised to fixing housing affordability all by itself.
Investment bank Citi thinks prices will fall by 7 per cent next year, while UBS thinks they will stagnate or grow by no more than 3 per cent. Both cite APRA’s clamp-down on investor activity as a core reason for the slowdown.
But even if the 7 per cent fall comes to pass, it will say nothing about the ongoing need to reform negative gearing and the capital gains tax discount – the two tax breaks that have worked together to pump up prices.
Why? Because as covered previously, the two laws have been a ‘tide that lifts all boats’. They have dramatically raised the borrowing threshold at which investors can still make a financial return.
In a genuine ‘market’, investors would base their calculations on the rent they were likely to receive from a property. If their mortgage and property maintenance costs exceeded rents, they’d make a loss.
The twin tax breaks change that equation fundamentally. Renting a property out at a loss becomes worthwhile, because the tax man allows the amount of that loss to be cut off your other taxable income.
The steadily growing number of investors using property to avoid tax in this way has meant house prices – and therefore an investor’s capital gain – have gone up and up.
Most important of all, when a property is sold and the capital gain is realised, the investor only has to pay half their marginal tax rate on the profits. If you’re in the 45 per cent tax bracket, that’s a huge saving.
When these factors are plugged into a mortgage broker’s computer, the level of debt investors can carry, while still making a good financial return, has gone through the roof.
So many barbecue-stopping arguments over ‘negative gearing’ are missing a key point – it was the Howard government’s halving of capital gains tax in 1999 that started the huge run-up in prices that are now reaching a peak.
The Coalition went to the last election saying it would not touch negative gearing or the CGT discount.
However, persistent rumours have swirled around Canberra that a CGT change was being modelled by Treasury, and that a ‘shaving’ of the CGT discount from 50 per cent to 40 per cent will make it into next Tuesday’s budget.
That would support Mr Morrison’s assertion that a fragile housing market should be reformed with a “scalpel, not a sledgehammer”.
It’s a powerful metaphor, but one quite divorced from reality.
Labor’s policy of excluding all currently negatively geared properties from its reforms, plus reducing the CGT from 50 to 25 per cent, is more like applying a gentle brake to a runaway train.
Market distortions would ease over time, but would take many years to do so.
Alongside that reform, a reduction in CGT from 50 per cent to 40 per cent would be like sprinkling rose petals along the track to slow things down.
A time for bold reform
Politicians and journalists with young children – and yes, I’m one – will one day have to explain to them how things got so out of hand.
A more embarrassing question will be: ‘Why didn’t you change the capital gains tax discount when there were no capital gains?’
What that future questioner will be referring to is the period, already identified by UBS, Citi and others, in which prices will be falling or flat. Capital losses, not gains, will be the order of the day.
That’s the perfect time to make a substantial change – when capital gains are muted, and when a lower CGT discount can help bolster a struggling federal budget.
It is well past time to turn housing into a genuine market, where prices are set only by supply and demand, not by laws designed to encourage tax avoidance.