Government housing policy in Australia encourages speculation, reduces home ownership and redistributes wealth towards the already affluent. It distorts capital away from productive towards speculative investments and reduces the competitiveness of Australian businesses across the country.
It’s a complete rort, though a lucrative one, which the housing lobby desperately wants to maintain.
A new report on negative gearing and the capital gains tax authored by ACIL Allen Consulting on behalf of the Property Council of Australia and the Real Estate Institute of Australia argues that removing such measures would “distort investment decisions away from property and towards other asset classes”.
It’s a bit like arguing that introducing a carbon tax distorted investment away from the coal sector. That might be the case in a simplistic sense. In reality, such measures are designed to fix an existing market distortion, whether it be -- as in the case of the carbon tax -- too much pollution or in the case of negative gearing and the CGT, excessive and unproductive property investment.
The Australian system of negative gearing is unusual by international standards. Only two other countries in the OECD (New Zealand and Japan) allow full deductibility of losses from property and shares to be offset against all sources of income.
Most countries offer a more limited form of negative gearing that quarantines losses from a particular asset class against future gains from the same asset class. The Australian system offers a greater incentive for investment in property and shares.
Ken Morrison, the chief executive of the Property Council, said that negative gearing and the CGT discount helped to improve housing affordability.
“They tick all the boxes by increasing supply, giving people an opportunity to get into the housing market and helping ordinary Australians build wealth for their future,” Morrison said.
In reality, these policies have been associated with a significant fall in home ownership rates across most age groups. The housing market has become increasingly concentrated, which has created a country of landlords and renters. Housing policy has become a tax haven for the wealthy, which redistributes wealth from the young and poor towards the already affluent.
A chief problem with the report is that it assumes that the housing sector is normal. It assumes that the property market, including the existence of negative gearing and the CGT discount, is exactly as it should be. But the property market has been vastly different in the past: there is clear evidence that these policies have shifted household behaviour.
There is several channels though which this becomes obvious. Investor activity and the size of net rental losses are two key areas in which these policies have fundamentally distorted behaviour.
Based on the latest data, new construction accounts for just 6.5 per cent of the total value of investor loan approvals. By comparison, new construction accounted for around 13 per cent of investor activity in 1999 before the introduction of the CGT discount and about 55 per cent of activity in 1986 prior to the Hawke government’s decision to reinstate unrestricted negative gearing on residential property.
Investor housing finance commitments, share of total investor loans
Australia, despite being among the wealthiest countries in the world, increasingly has had to rely on foreign investment to fund residential construction. According to the Foreign Investment Review Board, foreign investment approvals for Australian real estate reached $34.7 billion in the 2013-14 financial year -- more than double the level of investment the previous year.
The value of foreign investment approvals was 4.6 times as large as new construction approvals from domestic investors during the 2013-14 financial year. Foreign investment in Australian real estate is expected to rise rapidly in the medium-term.
As a result, neither negative gearing nor the CGT discount appear to be particularly important for maintaining the rise in housing supply. Quarantining negative gearing against new construction would, in any case, be a more efficient mechanism to improving construction.
According to the report, two-thirds of rental property owners who made a loss on their investment properties earned a taxable income of $80,001 or less. These data were debunked in an excellent article by ABC’s business writer Michael Janda last year.
It would take a particularly naïve individual to believe that 7.8 per cent of property investors earn less than $6,000 a year. Furthermore, it remains unlikely that 28 per cent of property investors earn less than $37,000.
It’s also necessary to put the figures themselves in perspective. According to the ATO data, the medium taxable income is around $53,000; by that standard an individual with a taxable income of $80,000 is already a high income earner. An individual with a taxable income of $100,000, for example, is among the top 15 per cent of income earners.
Number and value of net rental loss, by taxable income group, 2012-13
This busts the myth that property investors are generally middle-income ‘mum and dad’ investors. Those investors exist, but the vast majority of tax concessions from negative gearing accrue to wealthy Australians.
Shifting attention away from negative gearing for a moment, the impact of the CGT discount on household behaviour can most easily be seen by analysing the net rental loss on residential property.
Until 2000, property investment was pretty much neutral from an income perspective. Since then Australians have lost billions in rental income annually, which reflects the significant premium they now pay on Australian property.
Although rents are quite high in Australia, they have failed to keep pace with dwelling price growth. As a result, rental yields in Australia are low by international standards.
Australian Net Rental Income
The report largely ignores the potential impact that our capital gains arrangement has had on property prices. The graph above highlights the extent to which it has distorted the house price-to-rent ratio while the graph below shows that it has led to a significant increase in the house price-to-income ratio.
The house price-to-income ratio has increased by 44 per cent since the CGT discount was introduced in September 1999. The CGT discount isn’t solely to blame for this development -- the structural decline in interest rates has also contributed -- but it is no coincidence that property prices exploded the moment the Howard Government introduced a more favourable capital gains regime.
Negative gearing also contributes significantly to property prices. A report by Moody’s released last year said that negative gearing adds around 9 per cent to current home prices.
There has been widespread speculation that removing negative gearing will increase rents. The evidence supporting this theory is specious at best. The only conclusion we can make is that removing negative gearing will increase rental yields.
Prices would likely fall since in the absence of negative gearing, a significant share of property investment would no longer make sense. Those properties would likely be snapped up by renters, which would boost home ownership rates and reduce both the demand and supply for rental properties.
That last point is important because it complicates the analysis. If removing negative gearing only reduces rental supply then we could safely say that rents would rise. But weaker demand for rental property would also put downward pressure on rents. As a result, it remains ambiguous whether rents would rise or fall.
If the goal of housing policy is to distort capital flows, reduce home ownership rates, redistribute vast amounts of wealth towards the already affluent and reduce the competitiveness of Australian businesses then negative gearing and the CGT discount were impeccably designed.
But if we want to foster productive investment, stronger productivity growth and more affordable housing then it may be time for our federal politicians to reconsider their misguided approach to residential property and start ignoring the influential housing lobby.