Clearing up some misconceptions about Negative Gearing
John Daley’s paper recommends major changes to Australia’s negative gearing provisions.
Firstly, it proposes to only allow deductibility of net rental losses against other investment income.
This is despite the findings of Labor’s 2010 Australia’s Future Tax System (AFTS) Review, which, after a comprehensive analysis, supported the principle of being able to deduct net rental losses from wage and salary income.
Secondly, Daley’s paper recommends reducing the capital gains tax discount to 25 per cent; again this is despite the more modest AFTS recommendation to reduce the discount to 40 per cent.
Daley proposes phasing both tax changes in over 10 years, but will not grandfather existing investments.
Neither of those latter two features are part of Labor’s negative gearing and capital gains tax policies. And Daley argues against the Labor proposal to limit negative gearing to new residential property.
So while there are a number of similarities between Daley’s proposals and Labor’s, it would be incorrect to say that his paper advocates adopting Labor’s position on negative gearing and the capital gains tax discount. It also does not advocate using the proceeds to finance more spending.
I have a great deal of respect for John Daley and the Grattan Institute, but on this occasion they have it wrong.
Unfortunately, the paper is littered with factually incorrect statements, claims that are unsupported by evidence and direct contradictions. And its economic analysis in many places leaves a lot to be desired.
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.
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?
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?
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.
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.
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.
However, despite these and other shortcomings Daley’s paper confirms what the Coalition has been saying for several months now - but which the Labor party seems determined to deny: that removing negative gearing will reduce investor demand and result in lower residential property prices.
Daley estimates that his proposed negative gearing changes would raise an additional $2 billion in tax revenue each year from negatively geared investors.
Just think about that number for a moment.
Tax revenue always has to come from somewhere. In 2013-14, negatively geared investors earned gross rental income of $20.5 billion. So using Daley’s revenue estimate, we see that the effect of his proposed change would be similar in magnitude to a permanent 10 per cent fall in gross rental income for each and every one of Australia’s 1.26 million negatively geared property investors.
Mr Shorten and Labor argue that a shock of this size would have little or no adverse impact on confidence, investor willingness to pay, or the housing market more generally.
In contrast, the Coalition is of the firm view that it would significantly reduce investor demand and house values and lead to a range of other undesirable impacts.
To offset such a significant change, investors will seek to increase their pre-tax cash flows – and this will place upward pressure on rents.
Negatively geared investors would also seek to cut back on maintenance and repairs and would reduce other costs in an effort to reduce their net rental losses. Over the longer term, as the market adjusts to the fall in investor demand, there would be fewer rental properties, as existing dwellings fall into disrepair and are withdrawn from the market. In the UK and the US, which have removed negative gearing, the resulting crisis in rental markets has caused serious hardship and forced governments to spend billions of dollars in subsidies.
Nobody wants to see that happen - except, apparently, Mr Shorten and the Labor Party.