More Media Coverage About Negative Gearing

As we get another week closer to the federal election and the federal budget just a week away, media ramps up the coverage about negative gearing. We should begin with the what negative gearing is;

The definition of negative gearing;

 “Negative gearing is a practice whereby an investor borrows money to acquire an income-producing investment property and expects the gross income generated by the investment, at least in the short term, to be less than the cost of owning and managing the investment, including depreciation and interest charged on the loan (but excluding capital repayments). The arrangement is a form of financial leverage. The investor may enter into such an arrangement and expect the tax benefits (if any) and the capital gain on the investment, when the investment is ultimately disposed of, to exceed the accumulated losses of holding the investment.” 

The media should stop talking about negative gearing as though it represents property investors exclusively. Negative gearing also represents margin loans. An example of this is borrowing to purchase shares whose dividends fall short of interest costs. A common type of loan to finance such a transaction is called a margin loan. According to the Reserve Bank of Australia (RBA), total outstanding margin debt stood at $11.68 billion as at March 2015, compared to its peak of $41.6 billion in December 2007. That of course, doesn’t include the number of households that took out a 100% loan against their properties or investment properties to purchase shares.

Here are the reasons as to why PM Malcolm Turnbull and LNP have decided not to make changes to negative gearing for property. When responding to the media as to why the federal government are not implementing any of the suggestions made by the Grattan Institute;

  1. The paper claims that negative gearing “goes beyond generally accepted principles for offsetting losses against gains”.  But this is factually incorrect.  The ability to deduct interest and other costs from personal exertion income has been a generally accepted principle in Australia’s tax system for more than a hundred years. While there are some exceptions to this principle, they have been strictly limited to instances of flagrant abuse (as was claimed to occur with ‘hobby farms’) or to situations where taxpayers might use losses to gain welfare benefits.
  2. The paper argues that negative gearing and the CGT discount create significant distortions in the housing market, but then directly contradicts this when it says that changing them will have little impact.  Really?  How can changing the policies that Mr Daley says are supposed to create such huge distortions have no impact?
  3. The paper argues that negative gearing benefits wealthier taxpayers. However, in countries which have adopted the ‘quarantining’ approach, the result has been to drive middle and low income earners out of the investment market, as they cannot afford to carry the loss-making periods when costs are high relative to rentals. In contrast, under both Daley’s proposal and Labor’s, wealthy Australians would continue to be able to deduct net rental losses from their other investment and property income. How can a change which would actually make the tax system more advantageous to those on higher incomes be fair? How will it improve wealth inequality when it will make it more difficult for those on lower incomes to build up wealth?
  4. The paper ignores the fact that reducing the CGT discount to 25 per cent would give Australia the second highest CGT rate among comparable countries. While the paper claims this too would have no harmful impacts, that assertion is directly contrary to the evidence, which it systematically ignores. 
  5. The paper also ignores the fact that under reasonable assumptions, if the CGT discount was reduced to 25 per cent, the effective tax rate on real capital gains would, under reasonable assumptions be close to 70 per cent.  As a result, the paper dismisses with little analysis, the important point that high rates of capital gains discourage entrepreneurial investment, whose returns generally come in the form of capital gains.   
  6. Removing negative gearing would mean a tax increase for wage and salary earners and would affect incentives to work. The paper ignores these efficiency costs.