In a recent interview with the ABC’s Leigh Sales, Prime Minister Malcolm Turnbull defended negative gearing as “income tax 101”, by which he went on to explain as “a fundamental principle of tax law and has been forever that you can deduct from your income the interest expense of money that is borrowed to purchase an income-producing asset”.
This is quite a common proposition put forward by those who wish to defend the practice. It allows individuals who borrow finance the acquisition of an investment asset to offset the excess of interest they pay on those borrowings over the income the investment produces, in any given year, against their other income (for example, from wages and salaries) to reduce the amount of income tax they would otherwise be liable for.
They argue that this simply allows individuals to do what businesses can – offset the costs of ‘doing business’ (including financing costs) against taxable business income.
However, it ignores a very important difference between the tax treatment of companies and individuals. Companies don’t get the 50 per cent tax discount on capital gains which individuals have done since 1999 (nor did they get the CPI inflation adjustment to the cost base of assets which individuals did between 1985 and 1999).
Once upon a time, Mr Turnbull appreciated this difference.
In a speech to a conference co-sponsored by The Australian newspaper and the Melbourne Institute of Applied Economic and Social Research in September 2005, he described negative gearing as a form of ‘tax avoidance’, one of the few open to PAYE and other ‘unincorporated’ taxpayers.
A month earlier in a paper co-authored with the ANU’s Jeromey Temple, Mr Turnbull observed that “Australia’s rules on negative gearing are very generous compared to many other countries”, noting that “the normal deductibility principles do not apply to negatively geared real estate such that the taxpayer is not obliged to demonstrate that the negatively geared property will generate positive cash flow at some point in the distant future” (emphasis added).
People are, of course, entitled to change their minds – especially when, as Maynard Keynes is supposed to have said, the facts change.
But the only relevant fact that appears to have changed between 2005 and today is that Mr Turnbull is heading a Coalition government, rather than being a backbencher in one, and he is confronting an Opposition advocating changes to negative gearing, unlike the Labor Opposition in 2005.
In their 2005 paper, Mr Turnbull and Dr Temple argued “the concessionary taxation of capital gains encourages people to invest in a manner which turns income into capital and, as in the case of negative gearing, allows them to deduct losses at, say, 48.5 per cent and then realise gains and pay tax at effectively half that rate”.
They cited then Reserve Bank Governor Ian Macfarlane and other commentators as claiming “this divergence in the taxation of income and capital coupled with negative gearing has contributed to the asset bubble in residential real estate”.
The only relevant things that have changed since then are that the top tax rate is now effectively 49 per cent, that capital city residential property prices are almost 75 per cent higher than they were then, and that Ian Macfarlane is no longer Governor of the Reserve Bank.
As Mr Turnbull acknowledged, most other countries with personal income tax regimes similar to ours don’t allow negative gearing in the way that we do. The US removed it (for investment properties) as part of a broader package of tax reforms in 1986 – with no apparent adverse consequences for the level of investment in the housing market.
And two of Mr Turnbull’s closest political soulmates – New Zealand’s John Key and Britain’s David Cameron – both recently introduced changes to their countries’ tax regimes explicitly designed to dampen speculative investment in housing.
New Zealand has subjected investment properties bought and sold within two years to income tax at the investor’s full marginal rate, with effect from 1 October last year. And last year’s UK Budget provided that, from 2017 onwards, landlords will no longer be able to deduct the cost of their mortgage interest from their rental income in calculating their taxable income.
Mr Turnbull would do well to follow the example set by these, electorally successful, centre-right Prime Ministers, as well as the inherent logic of his own opinions of a decade ago, rather than regurgitating the self-serving propaganda of parts of the property industry.
Saul Eslake is a leading Australian economist. He worked as the Chief Economist at the ANZ for 14 years and has worked at Bank of America-Merrill Lynch. Between 2009 and 2011, he was the Director of the Productivity Growth Program at the Grattan Institute. Visit his official website here.