Abolish negative gearing? Not on your nelly!

24th Jun 2015By: Greville Pabst

Strong price growth in Sydney and Melbourne property markets has reignited the long debated topic of negative gearing – at a time when record low interest rates mean the benefit of negative gearing is negligible.

Australia’s negative gearing taxation ruling for property was established in the 1980s to promote private investment in property as a means of increasing the supply of rental housing, and to relieve pressure on the public purse to provide and maintain the millions of residential rental dwellings required in Australia – not only for social housing but for millions of households that prefer renting.

In simple terms, negative gearing occurs when the costs, including mortgage interest and expenses, of an investment purchased with borrowed funds exceeds the income the asset produces. Negative gearing can be applied to many investment classes, including shares and dividends, but is arguably most commonly associated with property.

There is contention surrounding the taxation policy as it allows negatively geared investors to claim the loss from an investment property against their taxable income.

The topic creates clear divisions in opinion, with calls from opponents to scrap negative gearing tax benefits, claiming it stymies the affordability of home ownership, and is a tax haven for high income earners at a significant cost to tax revenue, further increasing the social divide between socioeconomic classes.

However, calls to scrap the policy fail to consider the implications for the supply of quality affordable housing in Australia. According to the last Census data, the public housing sector provides relatively little housing – reportedly 333,383 dwellings, with an occupancy rate of 98%. This is low when compared with the private sector, which is the second largest source of rental housing in the country, second only to home ownership.

The fact is, contrary to the views of opponents of negative gearing, Australia has among the highest rates of homeownership in the developed world, with an estimated 70% of Australian households owner-occupied, according to the Australian Bureau of Statistics.

There is no solid evidence to suggest negative gearing artificially inflates the residential housing market, making it less affordable for homebuyers. While it is true investor activity in Sydney and Melbourne is high at present due to improved lending affordability, low interest rates have also diminished negative gearing benefits to investors. Put simply, less interest paid on loans means reduced loss and hence fewer deductions, making negative gearing a periphery consideration for many investors.

In reality, wealth generated through property isn’t derived from negative gearing, but rather through capital growth – just ask the baby boomers. This is a benefit afforded to all property owners, whether a homebuyer or an investor.

Furthermore, assertions the policy reduces tax revenue are also untenable as the loss via an investor’s deductible mortgage interest is recouped in the form of income received by the lender.

The ramifications

If negative gearing were abolished, when interest rates eventually rise, the funding gap of owning an investment property would widen, forcing many landlords to increase rents, creating further rental stress for already financially stressed Australian renters.

The abolishment of the policy would make property a less attractive investment class, resulting in a drop in the number of private rental properties, placing greater pressure on already low vacancy rates, leading to almost certain rental increases.

Perhaps the most important consideration against the policy’s removal is the implications of the increased cost of owning an investment property, which would potentially pressure some investors to sell, increasing the supply of properties for sale. Even despite significant demand in Sydney and Melbourne, the property market could take several years to absorb the oversupply of properties entirely, if at all, in some Australian cities. The increased supply would apply downward pressure on many property classes with ramifications for the financial position of existing homeowners.

The Government’s decision to support the rental market through incentivising private property investment encourages financial independence and a means to grow personal wealth, in order to minimise Australia’s ageing population’s reliance on government welfare in retirement years.