Are you against negative gearing?

March 31st, 2011

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Yesterday, the major newspaper reported on the First Home Buyer price strike on the front pages. Judging from the numerous vitriol and insults in the ensuing comments of the article, it is very clear that this social media campaign has touched the raw nerves of many. It goes to show that far too many people in Australia are too emotionally invested in property.

Related to this cause is the issue of negative gearing. Economist Saul Eslake put it the best in yesterday’s Sydney Morning Herald article- Imagine a tax system that penalised work. If you feel very much against negative gearing, you may want to join this Facebook cause: End negative gearing tax subsidy, affordable housing for next generation.

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  • DavidL

    Well, in the USA we need a tax system that penalizes work; we have 20 percent unemployment. If the tax system could get people out of jobs, that would open up jobs for the millions looking for work!

  • Matt

    I don’t really rate negtive gearing as big an influence as people make out. Unrelenting bank credit expansion (ie money expansion by private banks) is the real illness – property prices are just another symptom. Hey it’s fiat currency and privatised fractional reserve banking with a central bank to backstop it all – who knows what crazy monsters are going to come out of that mix!!

  • Interestingly, former finance minister, Lindsay Tanner confessed that ?The key reason why governments of both persuasions have not interfered with negative gearing is of course that that any dramatic change in the overall investment framework could lead to a stampede of people out of property, which could lead therefore to dramatic drops in prices…?

  • Matt

    I can see a case where tax concessions make property an attractive destination for expanding bank credit, but which is the stronger or lead force? Does expanding bank credit drive prices or does concessions such as negative gearing drive the expansion of bank credit? Probably a mix of both I guess.

  • Pete

    I guess you could look at it this way: If negative gearing didn’t exist, the banks could still loan the same amount of money, but the speculators wouldn’t want to borrow it as they’d have to pay too much of their disposable income to keep the property, if the rent/mortgage ratio was low.

    So, that means that rent/mortgage ratio’s would have to be higher without negative gearing, which means either higher rents (won’t happen) or lower prices.

    So in essence, banks could go absolutely crazy with credit and loan Joe Bloggs on a 50K wage a million dollars for property… but Joe wouldn’t be able to maintain the loan (pay the interest) without negative gearing as the rents wouldn’t cover it.

    This means that the irresponsible banks enable the financing for the speculation, whilst the negative gearing enables the speculation to grow over the longer term, forcing prices higher and higher.

    I’d say negative gearing is the driver, and banks are the enabler.

  • Matt

    Cheers Pete, so how about the run in stocks and now commodities? It seems that there is always a puch for further credit expansion somewhere and housing (due to tax incentives) has made a pretty good home for it over the last 15 or so years. When the credit expansion slows it’ll likely be the federal government that steps in to fill the void (housing being the receptical for credit money expansion when the Liberals were paying down the debt?).

    So how much of an influence does negative gearing have – take the average negative gearing loss (say $10,000 p/yr), times it by the average tax rate (say 30%) = $3,000, leverage the $3,000 onto additional mortgage interest payments that can be made (say 7% avg mortgage rate) – math is getting fuzy now so $3,000/0.07 = $42k increase in price due to negative gearing – pretty substantial. 10% of the average home price i guess.

    – of course all those assumptions i used could be way off – average negative gearing loss may be twice my guess. Also if you take the negative gearing on a new purchase (thats where it matters anyway right – new purchases you’d have a much larger loss on say a $450,000 property – probably up to $25k or so

  • Don’t forget, in negative gearing, you can include non-cash expense (eg depreciation) to reduce tax payable.

  • Matt

    Hi CIJ, I’ve written a couple of responses to Pete and they come up but when I come back to the page they have gone. Are they too long??

  • The Disqus spam filtering is overzealous in labelling comments as spam. I’ve digged through the spam pile and approve your comments and whitelist your name.

    Pete has got the same problem too.

  • Regarding point 3, Saul Eslake (who was formerly chief economist of ANZ and currently director of Grafton Institute), did a lot of research in that and found out that it wasn’t really true. See Imagine a tax system that penalised work.

  • Matt

    Cheers, i should actually sign in i suppose!

  • Another way to look at this: bank credit expansion result in bubbles and inflation.

    Tax policies (e.g. negative gearing and capital gains concession) steer the bubble towards property (and to certain extents, shares).

    Since banks are more willing to lend against property (as oppose to shares and businesses), that explains why property is more vulnerable to bubbles.

  • Matt

    Said so well!!

  • Matt

    They point to ”what happened” when the Hawke government abolished negative gearing (only for property investment) in 1986, claiming that it led to a surge in rents, which prompted the reintroduction of negative gearing in 1988.

    This assertion has attained the status of an urban myth, but it isn’t true. Rents (as measured in the consumer price index) did rise rapidly (at double-digit annual rates) in Sydney and Perth, but that was because in those two cities, rental vacancy rates were unusually low before negative gearing was abolished. In other state capitals (where vacancy rates were higher), growth in rentals was either unchanged or, in Melbourne, actually slowed.

    -What’s the average vacancy rate now? Double digit rent increases are pretty big but the other info (melb etc) points to a break down in the causal relationship there.

  • Matt

    And don’t forget that once it starts, the equity builds and allows further borrowing – doesn’t matter if its home mortgages, margin accounts or tulips!

  • Whether rents will increase or decrease when negative gearing is abolished depends on one thing (among other factors), in our opinion- the pricing power of landlord.

    If the landlord has pricing power, then he/she can easily pass the increase in cost to tennants. If not, he/she will lose tennants, which will exacerbate the losses.

    It also depends on how much more the tennant is able to pay the increase in rent. With cost of everything else rising and personal finance deteriorating as a result, some tennants may even default on their rents.

  • Matt

    True, i tend to think our ‘supply issues’ in the housing market have more to do with everyone wanting a big place to them selves and feeling like they can afford it rather than any actual supply problem. ie, if push comes to shove you could see a lot of spare rooms being converted back from ‘home office/guest room’

  • Pete

    I think the supply issues are because property is now used as an investment vehicle, instead of a home. We trade houses between us, at ever increasing values. This doesn’t mean they are all occupied…

    I generally agree with you, and CIJ made my other point for me about rents in the 90’s.

    This chart really helped me to understand it:
    http://img91.imageshack.us/img91/4893/realrentsvsrealinterestax1.png

    It shows interest rates vs ‘inflation adjusted’ rents.

    Take from it what you will…