ALP’s negative gearing plans could help homebuyers
The ALP’s proposals to cut back negative gearing and raise the capital gains tax could make housing more affordable but may not boost housing supply.
Australians who negatively gear housing investments are firmly in the firing line with both Labor and the Turnbull government pledging to move against the practice.
At the weekend, the ALP released its plan to claw back some of the tax concessions on offer for property investors, but the government is yet to to release its own plan.
Whatever it contains, there is one thing we know, regardless of who wins power at this year’s election – reining in negative gearing is now a bipartisan policy. The only disagreement is how it’s done.
So, what is negative gearing?
Negative gearing works like this. You borrow money to buy a rental property and tenants pay you a monthly rent.
If the yearly costs, including the interest on the loan, are more than your annual rental income, then the property is running at a loss and you can claim that loss against your taxable income from other sources.
That reduces your tax bill and helps you pay off a property worth more than you could otherwise afford.
The downside of the practice is that it pushes up prices for existing property. That’s because investors getting the tax breaks get a leg up on owner-occupiers who don’t get a tax deduction on the interest they pay.
Labor has pledged to restrict negative gearing to purchases of new properties from July 2017.
However Prime Minister Malcolm Turnbull is believed to favour either limiting the number of properties investors can negatively gear or the amount of their annual deductions.
Significantly, Labor also pledged to cut the discount on capital gains tax on assets owned for more than a year from 50 per cent to 25 per cent.
Taken together, the two Labor measures change the equation for property investors by reducing the attractiveness of existing properties to investors and increasing tax for profits from property investment.
Negative gearing is a highly politicised topic with proponents saying it is crucial to providing an adequate housing stock and detractors claiming it is pricing Gen Ys and millennials out of the housing market.
But all sides agree that changing the rules will change all segments of the market. These are the likely effects of Labor’s planned changes.
Existing home owners
Grattan Institute CEO John Daley says the proposed changes “would keep house prices a little lower than they might otherwise be”, because investors would be discouraged from buying existing housing.
“But overall the changes would be less than the fluctuations we see year on year in the market,” he said.
With property investment relatively less tax advantaged “we would see a few less renters and a few more owner-occupiers” as they improve their position in the market, Mr Daley said.
None of the proposed changes to negative gearing of the capital gains tax would apply to existing property investors whose current arrangements will remain in place. However they may see housing price growth slow.
The decreased attractiveness of existing properties would reduce the number of rental properties and as a result “rents might rise for lower-income people while those second property owners at the top might also be a little worse off”, says economist Professor John Freebairn of Melbourne University.
This is an area of controversy. The ALP says restricting negative gearing to new properties will boost supply but Graham Wolfe, policy chief with the Housing Industry Association, says it’s more complicated than that.
Add in the higher capital gains tax and the property investment equation looks way less attractive. “Many people don’t buy a house to get the negative gearing benefits as you’re still losing 50c in the dollar on rental losses (for those on the top tax rate),” Mr Wolfe said.
“They’re using it to help build their investment.”
So if tax is higher when the property is sold the whole strategy is less attractive meaning new construction won’t necessarily get a boost.
Capital gains tax
Official figures on negative gearing losses seem to lend weight to Mr Wolfe’s view. Prior to the halving of capital gains tax by Treasurer Peter Costello in 1999, net rental losses reported to the Australian Taxation Office were negligible.
But after 1999 negatively geared losses ballooned to a high of $9 billion in 2001-08 when interest rates peaked. In the current low interest rate environment it has fallen back to $5.39 billion.