Should negative gearing be scrapped?

Every time Australian residential property prices take off, calls erupt for negative gearing on investment property to be restricted or scrapped. Such calls are getting added currency now as some see it as a way to help close the budget deficit with a greater proportion of the dollar impact falling on higher income earners.

Such a move would clearly adversely affect property investors as it would, in effect, reduce the amount they can borrow.

However, such a move is of dubious merit from a range of perspectives.

First, negative gearing is not the reason housing affordability is so poor in Australia. It has been in place for a long time and Australia is not alone in providing some form of "tax assistance" to home owners, as most comparable countries do. Americans can even deduct interest on the family home from their taxable income. And yet our house-price-to-income ratios are much higher.

Removing or curtailing negative gearing could even make the situation worse by reducing the supply of rental accommodation at a time when rental yields are hardly attractive for investors.

Rather the real driver of poor housing affordability has been a lack of supply. In a well-functioning market, when demand goes up prices rise and this eventually is met with increased supply. Residential construction is now picking up but this follows more than a decade of undersupply that has to be made up. What we really need to do is to make it easier to bring new homes to the market - release land for development faster, relax (within reason) development controls, reduce tax and other impediments to the supply of new dwellings and develop a long-term plan to decentralise away from our major cities.

This would be the best way to help first-home buyers and cool speculative interest in housing. Curtailing negative gearing is not the solution.

Second, removing or restricting the deductibility of interest expenses incurred in property investment will cause a distortion in the tax system because negative gearing would still be available on other investments (so unfairly biasing investors in favour of, say, shares over property). Allowing deductions for expenses incurred in producing income is a standard and common-sense feature of our tax system.

Finally, calls to curtail negative gearing or other tax concessions need to be assessed in the context of the whole tax system. Australia already has a relatively high reliance on income tax and the top marginal rate at 49% is at the high end of comparable countries. Just 17% of individual taxpayers paid 63% of income tax revenue in 2011-12, according to the Australian government's tax discussion paper and this likely to have become even more skewed since then. Curtailing access to negative gearing will only add to the burden on this relatively small group and act as a disincentive for work effort at a time when we should be doing the opposite. Ideally we should be looking to reduce the reliance on income tax, and if we did this the interest in negatively gearing properties would be likely to decline anyway.

So hopefully common sense prevails on negative gearing and we can refocus on the real issue: making it easier to meet rising demand for Australian housing.

Shane Oliver is Head of investment strategy and chief economist, AMP Capital

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