How to Put Lipstick on a Pig (feat. Scott Morrison)

Negative gearing is a lot like climate change. Amongst academics, economists, and public servants, there is a widespread consensus about the effects of negative gearing – it pushes up house prices, drives truly bizarre housing investment behaviour and doesn’t particularly increase rental stock. And yet, just like climate change, in the public domain, there is a “debate”. This article exists to dispel that debate.

First: some definitions. Let’s say you borrow money to buy an investment property, which you then rent out. The money you receive in rent is your income, and your costs will be a combination of interest payments on the loan and maintenance/other works on the house. In the event that you are making a loss (i.e. your costs (maintenance and interest payments) are greater than your income (rent received as a landlord), you are said to be “negatively gearing” the investment property (neutral gearing is where costs are equal to income, and positive gearing is where costs are less than income). That’s just definitions. The policy in contention is that currently, the loss from a negatively geared property can be deducted from taxable income (that is, income from both investments and from salaries/wages). That policy currently costs the Commonwealth government about $11 billion per year.

Now, at this point you could plausibly ask what could possibly warrant a price tag of $11 billion per year. Negative gearing purportedly has three goals: increasing rental supply, supporting mum and dad investors, and correcting an inefficiency in the tax system (I’ll explain what that means below).

Firstly, on increasing rental supply. The argument goes like this: if losses from negatively geared properties are able to be offset from taxable income, then more people will be willing to invest in rental properties because the losses will be smaller and the risk over going into loss is less severe. That argument is intuitively plausible. It is not supported by evidence. The issue with this argument is a fairly basic supply and demand analysis. As more people choose to invest, demand for housing goes up, and as a result, price for housing goes up. That will price some people out of the market. Those people then opt for renting, which pushes up the demand for rental properties (which therefore pushes up the price of rental properties). There are definitely more rental properties (higher supply), but this increase is almost directly proportional to the increase in renters (higher demand). Of course, this wouldn’t necessarily be true if there was a substantial construction of rental properties – then, even if there were more renters, it’s possible that there could be a net increase in rental supply. But there isn’t an overall increase in housing stock – 93% of property lending goes to purchases of existing residences. Rents don’t necessarily go down, nor is there any less of a rental shortage. No real benefit to be seen here.

Secondly, on supporting “mum and dad investors” (note: “mum and dad investors” is a loosely defined political term generally used to refer to middle-class parent investors without a strong investment history). The argument here goes that a huge portion of those who negatively gear investment properties are not the super wealthy, but in fact regular Australians who are just looking to improve their lot in life. While this argument has rhetorical value, appealing to the Aussie battler, there are incredibly strong counterarguments to this. The first is that many negative gearers only negatively gear because they cannot afford to buy. The loose intuition goes as follows: house prices have risen (in part due to negative gearing), and as a result, it is cheaper to negatively gear a house and use the rental income from that to rent a house of one’s own. Why is that true? Well, think about it this way. If you buy a house, you have to pay the mortgage on that house. You can eventually sell that house, and you will receive money from that sale (because house prices increase faster than inflation, selling a house means that you generally make a profit – this profit is known as “capital gains”). That capital gain is the only source of income if you are an owner-occupier from the get-go. By contrast, if you negatively gear and also rent your own property, you can effectively offset the rent you pay for your own home with the rent you receive from your investment home, and you still get the capital gains from eventually selling that investment home, but now your losses (the mortgage payments on your investment home) are partially subsidised by the government. This way, eventually, you can sell your investment home and buy your own in the future, as opposed to having lower wealth and simply buying it now. Hence why John Daley, CEO of the Grattan Institute (one of Australia’s most reputable think tanks) claims that negative gearing leads to “distorted” and “anti-social” housing outcomes: it means that people who would have preferred to own their own home cannot, and therefore purchase an investment property (further increasing house prices) so that they can rent out a home in order to pay rent for their own home. Undoubtedly, some of these “mum and dad investors” would actively want to invest with or without the policy, but I’d hazard a guess that most “mums and dads” would opt for owning their own home over some bizarre wealth-transfer scheme that still leads to them owning their own home, but much further down the track.

There’s a second counterargument on “mum and dad investors” – most of the money isn’t going to average Joe and Jane mum and dads. Around 50% of the $11 billion goes to the top 10% of income earners. Moreover, the relative proportion of negative gearers per occupation correlates to income – 30% of anaesthetists negatively gear as opposed to just under 5% of cleaners. When Scott Morrison says that 38,390 nurses negatively geared last year as some means of proving that regular Aussies are beneficiaries of this policy, remember that there are well over 300,000 nurses in the country. The proportions do not, as a general rule, support the hypothesis that people on lower incomes negatively gear.

To the above, Malcolm Turnbull would say that it is “beside the point” how many rich Australians use negative gearing – it is still benefiting at least some middle-income earners. That is true until you remember the price tag. That $11 billion per year is money that can’t be spent on other government programs – government programs which could very actively support all middle-income earners, as opposed to the minority who negatively gear. If we care about increasing the incomes of middle-income earners without giving unnecessary tax reductions to the rich, we could simply increase tax brackets such that middle-income earners pay less. Or we could use that money to plug the budget deficit without using savings like a GP co-payment, or to pay for all of Gonski such that fewer parents felt the need to spend money on a private education. Or, to counter the point on rental supply, we could explicitly construct a huge amount of public or low-rent housing for far less than $11 billion. This isn’t to say that those policies are good or bad – that’s for a different article – but insofar as Malcolm Turnbull wants to make the “point” of negative gearing giving a little extra dosh to “mum and dad Australians”, there are far more direct and less pricey ways of achieving exactly that.

That gives us one final benefit, which is fixing the inefficiency in the tax system. The ANU’s very own Martin Richardson correctly points out that without the tax deductibility of negative gearing, the housing market arbitrarily benefits those who finance their investment properties through equity (loosely meaning money that they already had rather than money that they borrowed) as opposed to debt. This is true, and ideally, a tax system would treat all investment equally. This benefit is not irrelevant, but it does carry with it a question – how much do we value a perfect tax system? Do we value it at $11 billion per year? As outlined above, that is $11 billion we cannot spend elsewhere, and it must be balanced against the costs of low home-ownership, low long-term rental property rates, and an increasingly volatile housing market. A cursory analysis would not come off in its favour.

Negative gearing is popular with governments because it buys important votes – electors in marginal seats like the capacity to negatively gear their second or third investment properties. But for the average Australian, negative gearing is a basket of trouble – it does not meaningfully increase rental stock, it doesn’t help “mums and dads” and it doesn’t have a sufficient efficiency impact to warrant its costs. Scott Morrison may dress negative gearing up in all the rhetoric he can muster, but it remains nothing but an expensive vote-buying policy that costs everyday Australians a lot more than it gives.