Where’s My Castle?: Understanding Negative Gearing

Affordable housing is a hot topic in Australian politics, and it is a complex policy issue. The housing market is heavily regulated in Australia, and it has many demand-side and supply-side distortions that make it difficult to isolate the root cause (if there is one) of the rapid rise in housing prices. The rise in house prices itself is not a problem if real income growth were to increase at a similar rate, but it does not. The result is that many young potential first-home buyers are locked out of the market.

I would like to focus on one aspect of the issue: negative gearing. As a demand-side distortion, it increases the demand for houses, thus increasing the price. The Coalition Government and the ALP have distinctly different approaches to negative gearing, with Treasurer Scott Morrison firmly rejecting changes to negative gearing, and Opposition Leader Bill Shorten decidedly arguing for adjustments to be made.

Firstly, what is negative gearing? First introduced by the Hawke Government in 1985, it is a tax principle that allows investors who run their investment at a loss to claim that loss against their other income. It is not restricted to property investors but is mainly applicable to property. Rental properties are run at a loss usually because the investor borrows most of the price of the property, and the interest payments on the mortgage are higher than the rent. This means that if I make a monthly loss of $100 on my property, I can reduce $100 of my taxable income from other sources – like my salary – and therefore pay less tax. It is estimated that the Government forgoes about $15 billion in tax revenue every year due to negative gearing.

Negative gearing benefits high-income earners far more than low-income earners. It is essentially a tax deduction, so if you were earning a salary in the highest tax bracket, say, $300,000 – you would get about 50 per cent of your loss back. If you were earning on the lowest tax bracket, say, $20,000, you would only get about 20 per cent of your loss back. Thus, Scott Morrison’s claim that most property investors are ‘mum and dad’ investors may be true, but the vast majority of the $15 billion in foregone tax revenue goes to high-income earners.

Initially, negative gearing had two main goals. It aimed firstly to encourage low rents by ensuring investors can still make a profit off low rents, and secondly, to stimulate the construction industry by increasing demand for property. There is no evidence that negative gearing has resulted in these two effects. In fact, Shadow Treasurer Chris Bowen argues 93 per cent of negatively geared properties were existing homes. The ALP proposal to limit negative gearing to new properties may help to address this issue.

So why is negative gearing so popular? Surely a loss is still a loss, even if you are able to claim some percentage of it back in tax deductions. Negative gearing only works in tandem with capital gains: that is, buying low and selling high. If house prices are increasing, a rise in the price of the property offsets any losses incurred through negative gearing. Furthermore, if you hold a property for more than 12 months, only 50 per cent of any capital gains you make are actually taxable.

But there is also a much deeper reason. Negative gearing has become synonymous with property investment and is now the next step after home ownership. It’s another chapter in the ‘Australian Dream’ for Baby Boomers who have paid off their mortgage. It’s the story of personal aspiration, as property investment is seen as the safest way to increase one’s wealth and therefore a path to upward economic mobility. It is also a partial explanation for why many middle-class people may object to increases in taxes to the upper class: they believe and hope that one day, that might be them.

Nowhere is it more evident than in Scott Morrison’s latest speech to the Australian Housing and Urban Research Institute. He talks about ‘mum and dad investors’, which he argues are the focus of the negative gearing program and a positive force for the economy. He paints it as un-Australian to be against negative gearing: one in five police officers own an investment property, as do around 58,000 teachers. The argument being made by Morrison and supporters here is that any attempt to change the policy would essentially be making police officers and teachers worse off.

Be that as it may, there are 160,000 young people who would otherwise be homeowners. It does not make sense, to me, that this argument appeals to some Australian aspiration for an investment property when it comes at a cost to the more fundamental aspiration to own a home.

More than two million Australians own or benefit from investment properties, which is just under 10 per cent of the population. Of the properties owned by these Australians, 1.3 million are negatively geared. 72 per cent of these owners only own one investment property, and 90 per cent less than two. It does not make sense that a tiny minority of the population who own more than one or two investment properties should be able to benefit from negatively gearing their fifth or sixth investment property.

Of course, negative gearing is only one part of the complex housing issue in Australia. Fixing negative gearing or any other policy, in isolation, will not be a silver bullet. The Government needs to work on a comprehensive policy that addresses Federal and State incentives for demand, as well as regulation of the supply side of the housing market. Perhaps the Government should institute a ‘smashed avocado’ savings plan: for every smashed avocado a millennial does not eat and puts towards a savings plan, the Government will contribute the same amount to the plan.

Otherwise, thousands of young Australians and their families may never live in a home that they own. This should send a chill through us, collectively: As Darryl Kerrigan argues in The Castle, ‘It is right and fair that a family be allowed to live in its own house. That is justice.’