Posts Tagged‘capital gains’

Why Targeting Negative Gearing Won’t Solve The Problem.

My generation has been very vocal about the struggle they have with the high cost of property in Australia. The argument is not without merit with our 2 largest cities often ranking in the top 10 most expensive places in the world to live. Indeed in the past I’ve said that Australian property is out of reach for an average person on a single income although I did conclude that this wasn’t representative of how most Australians buy their homes. Still one target that almost always comes up in discussions around housing affordability is that negative gearing isn’t doing anything to help the situation and its abolishment would lead to cheaper housing everywhere. Whilst I’m sure my vested interest in this topic (I have a negatively geared property, soon to be 2) will likely have most tuning out before this paragraph is over I’d urge you to read on as getting rid of negative gearing, or modifying it in a way you think appropriate, won’t bring prices down like you think they would.

Housing Prices

Taken by themselves the numbers around negative gearing do appear to be quite damning. Every year the government doles out about $4 billion worth of tax cuts to people who own negatively geared property, amounting to about 1% of total tax revenue. At the same time data would seem to indicate that  investors almost exclusively target established properties something which is at odds with the arguments that investors fund new property development. All this would seem to add up to a situation where investors are locking up existing property stocks which forces potential buyers out of the market. Whilst I’ll admit that negative gearing is a factor in all this it’s by no means the major contributor and making changes to it will likely not have the effects that many desire.

One proposed changes is to limit the number of properties that can be negatively geared to 1, putting a cap on the number of properties investors can draw benefits from. It sounds good in theory as it would put the kibosh on property barons snapping up large swaths of property however the fact is that the vast majority of property investors in Australia, to the tune of 72.8%, own only a single investment property. They in turn account for just over half the total number of investment properties in Australia. So whilst limiting negative gearing to a single property sounds like a good idea it would only affect half of the investment properties in Australia leaving the rest in the same situation as before.

Limiting negative gearing to new construction is an idea I’m on board with as it will more directly address the issue of housing supply rather than pushing investors away from property as an investment class. The one caveat I’d have to put on top of that would be the curtailing of the land agencies from charging exorbitant amounts for new land releases as that could easily erase any gains made from quarantining negative gearing in this fashion. Indeed if you look at just the land prices here in the nationals capital a small, 400m2 block will usually go for $400,000 meaning that even a modest house built there will cost upwards of $550,000. If you want to attract investors to building new properties then this is most certainly an issue that needs to be addressed prior to quarantining negative gearing.

However all of these ideas are flawed when you consider that there’s a much bigger tax break at work here that’s inflating property prices. As I’ve stated many times in the past Australian housing investors are something of a minority, accounting for around 20% of the housing market. Therefore it’s hard to believe that negative gearing is solely responsible for Australia’s house prices as the majority of the market is because of owner occupiers. What I didn’t mention in that previous post is the tax breaks that owner-occupiers receive in the form of exemptions from capital gains tax. Essentially when you sell your primary place of residence you don’t pay any tax on any gains that property may have made while you owned it which puts a strong upward pressure on prices (people want to maximise gains), enabling them to trade up to bigger and better houses.

That sounds fine in principle but it costs taxpayers a staggering $36 billion a year, 9 times that of negative gearing. You wouldn’t even have to abolish this to see savings far in excess of what getting rid of negative gearing would achieve. Instituting a 50% reduction in the capital gains tax payable (like is done currently with shares) for the sale of your primary place of residence would generate $18 billion a year and put a heavy downward pressure on property prices. Hell you could even apply the new construction only exception to this as well, giving people who build new houses something like 5 years worth of capital gains tax free whilst ensuring everyone else paid up. Of course this solution is a little less palatable since it targets everyone and no just those dirty investors but it would be far more effective.

Many will argue that abolishing negative gearing is a good first step towards solving the problem but in all honesty I don’t feel it will have the impact that it’s advocates think it will. Australian investors, whilst being a factor in housing prices, aren’t the major contributor with that responsibility falling to the Australian dream of owning ever bigger and better homes. Fixing the supply issue is a multi-faceted affair and if you want to attract investor dollars to it the solution has to be much more nuanced than simply removing one piece of legislation. You might not like it, hell I don’t like limiting things to new construction but I’ll agree it would work, but we have to face the fact that targeting Australian property investors likely won’t get us very far.