How entrenched is negative gearing?

By Gavin R. Putland

According to pre-Budget leaks reported by SBS on 3 April, and confirmed by Louis Christopher on 9 April, Treasury and the Parliamentary Budget Office have modelled a proposal to disallow negative gearing (NG) on future purchases of established homes, while still allowing it for new homes and grandfathering past acquisitions.

On 15 April, Jennifer Duke in Property Observer mentioned "Grandfathering negative gearing out, limiting it to new properties", and quoted Propell National Valuers as saying: "If the system is not changed this year, then property investors can probably relax in the knowledge that it will become a permanent feature of the investment landscape."

On 21 April, also in Property Observer, Propell followed up with "Five reasons the government might consider changing negative gearing this year", without mentioning the possibility of limiting NG to new builds. In short, their reasons were:

• Interest rates are low, limiting the number of investors affected (although grandfathering would neutralize this);

• Prices are on the upswing;

• Any fall in prices would allow lower interest rates, hence a lower dollar, helping exporters;

• Frustrated first home buyers (FHBs) are a substantial constituency (although still a minority), and would welcome both lower prices and lower interest rates;

• Reduced competition from investors would be welcomed by FHBs and upgraders.

I might have added:

• Limiting FHB grants to new homes has made FHBs uncompetitive in the market for established homes. A corresponding restriction of negative gearing would compensate.

• In a Budget that was going to slash welfare and abolish the mining tax, the Government needed a token contribution from the well-off.

Then the Government revealed that the token contribution would be a temporary income-tax surcharge on high earners, which would be partly avoided by shifting taxable income out of the affected years. And on Budget night, it was all quiet on the negative gearing front.

I was reminded of the first Howard/Costello Budget in 1996, in which the Government broke its "non-core" promises by cutting health, education and welfare. It needed a token contribution from the rich, and chose a tax surcharge on the earnings of superannuation funds for members whose income plus contributions exceeded a threshold. An early media report on the operation of the scheme alleged that the compliance cost was (if memory serves) 57% of the revenue raised. Not surprisingly, the surcharge was eventually abandoned because it was too complicated. In particular, it was too difficult to impute the earnings of funds to individual members for the purpose of taxing the members — a lesson that Labor failed to learn before attempting its own "progressive" super reforms.

In each case, of course, limiting NG to new homes would have been better policy. Had this been done in 1996, it would have slowed or prevented the inflation of the subsequent housing bubble, and Australia's financial system would have been in better shape when the GFC struck. Instead, our "global" crisis was compounded by a home-grown property bust. And then the Rudd government, in its efforts to restart construction, was apparently willing to do anything but require construction as a condition of negative gearing!

So the precedents suggest that whenever a government feels a need to slug the well-off, the chosen instrument is unlikely to be as sensible as limiting negative gearing to new homes, and more likely to be ham-fisted, temporary, hypocritical, and perhaps even designed to fail.

The one remaining hope is that the aforesaid modelling by Treasury and the Parliamentary Budget Office was less about the Budget than about the upcoming Tax Reform White Paper. That would be consistent with the relevant recommendation in the Murray Inquiry's Interim Report. Already the wagons are circling.

Hope is not dead, but it's getting a bit long in the tooth.

[Last modified 17 July 2014.]