Cutting back tax deductions for property investors would erode housing affordability, reduce housing supply and bump up rents, a new report says.
The report, commissioned by the Housing Industry Association, says reducing negative gearing would diminish the incentive to invest in housing and exacerbate current undersupply, pushing rents almost one per cent higher.
Negative gearing allows investors to fully deduct costs associated with a rental property against their income, reducing their tax liability.
It has long been criticised as a policy that hurts housing affordability and the 2010 Henry Tax Review recommended reducing the level of tax deductions available from negative gearing by 40 per cent.
But the report on Monday says discounting negative gearing would worsen housing supply issues.
"Under current housing policy settings, discounting residential negative gearing would lower Australian living standards by making the tax system less efficient," the report says.
"The discount would add to the already high tax burden in the housing market, exacerbating the current undersupply of housing and, therefore, further reducing the efficiency of the housing market.
"Adding to the tax burden on rental properties reduces the incentive to invest in housing, and therefore reduces housing supply.
"This lower supply raises the cost of housing for both renters and owner occupiers."
Abolishing stamp duty on property transfers, however, would improve housing affordability and living standards, by removing barriers to investing, the report said.
Stamp duty also discourages people from moving house even though it could better suit their needs, preventing the current stock of housing from being used efficiently, it said.
The report said an estimated $7 billion was paid in stamp duty on residential property conveyances in 2011/12, with $1.3 billion offset by negative gearing.
A residential negative gearing discount could only be beneficial if stamp duty was abolished, the report said.
"Rather than introducing a discount to residential negative gearing in isolation, other related recommendations of the Henry Tax Review, in particular replacing stamp duty on conveyances, would need to be implemented first if an economic efficiency improvement is to be achieved," the report said.