"Tax reform group Prosper Australia today called on first home buyers to delay buying real estate ahead of the flip into a falling market, which it described as ‘imminent’.

Australia’s housing market is widely regarded as being in a price bubble and ‘most severely unaffordable".

http://suggest.getup.org.au/forums/60819-campaign-ideas

High house prices push people towards renting, but house prices appear to be overpriced.

So why is this so?

When the bubble burst, more than a few fingers will get burnt.

I suppose questions should be asked, why is Australia becoming so expensive?

Yet in the time of a socalled boom, where is all the money from taxation going? as it is not being spent on roads, rail, or our public hospitals.

meh .. we've been in a housing bubble for over 30 years haven't we?

I have been hearing for years now the pundits saying the bubble will burst, any minute, now please panic .. do we ever hold these idiots to account when their predictions fail, pity.

It won't, it's not a bubble. Bubbles have little of value behind them and all fall when someone refuses to pay the price. I know many economists call it that, and classically it may appear so, but people pay the price and receive value, hence it is not a bubble.

Now if the economy tanks, that's another story, but with all the stuff under the ground here and China going gangbusters, it won't happen.

As long as people want to improve themselves and their lot, they will aspire to better homes in better areas. So there is always an upward push.

Basic philosophy in buying housing is buy the most you can at any time. Don't buy a cheap house in an ordinary area as it won't grow, that is, not everyone wants to live there.

Do you really think people will stop moving, having bigger families and wanting a better lifestyle?

There is so much negative attitude in Australia and it seems to always stem from people who think we have more than we deserve, who feel guilty at our wealth, Saul.

Do you think all the people queuing up to come here to Australia all want to live in mud huts? They are coming here for a better life and will do their damndest to get to the top of the pile and the best house they can get, with a couple of investment properties thrown in because it's a better bet than any other investment currently in Australia, shares stink!

Interesting article.

I don’t buy the argument, or rather assumption, that the government, in allowing a person a tax deduction, is “giving” money to that person. This line of reasoning could only make sense if all property presumptively belonged to government in the first place. It’s back-the-front. People are not cattle owned by government. People who pay less tax than they conceivably might are not, for that reason, responsible for the fact that the government unfairly taxes others: - the government is. Stop blaming the victim, and start naming and shaming the bully.

“[T]he reason why ‘negative gearing’ will forever remain untouched [is] because (like grants to first home owners) the people who would experience declines in the value of their properties were it ever to be removed are far more likely to vote against a government which removed it (or an opposition party which promised to do it) than there are people who would benefit from lower property prices and would change their votes accordingly.”

But why? Why wouldn’t there be as many people who would benefit from lower property prices and vote accordingly?

But in any event, that is not an argument for *increasing* government’s gouging of productive activity. There is never any discussion in these proposals about the purposes of what government is taking it for in the first place. Why should government be presumed to have first dibs on everyone’s productive efforts, when the very arguments in favour, rest on a welter of evidence of the unfairness and incompetence of government at directing society and managing the economy. Why do they keep getting a "get-out-of-jail-free" card?

If the purpose of the exercise is to promote work and savings – STOP TAXING THEM and stop funding their opposites.

'pro-Palestine stand'?

I thought it was an anti-Jew stand.

Ask Mel Gibson, you just shouldn't mess with the Jews.

Sorry, The relevance of that post may be missed by some.

This is an excellent analysis of the problem. Negative gearing means people expect to get their profits from inflation in house values not from income from renting.

If it costs more to service the loan than is collected in rent then the property should be sold.

The fault also lies with banks who give what are clearly uneconomic loans to so called investors. Banks could take more responsibility for such loans. Perhaps they could be encouraged to do so by invoking the National Responsible Lending Laws and refusing what are clearly uneconomic loans for investment housing.

Maybe this is a way to reduce the housing price bubble that exists in Australia. The banks could agree that they will stop funding such loans because it is irresponsible of them to do so. It would be hard for any political party to oppose this and it would get the politicians "off the hook".

I am one of those who benefit from the existing idiotic taxation system but have often pointed out the problems. This article matches my sentiment precisely.

I am an older self funded retired widower who earned around $2000 per week through leveraged investments over the last several years but I received average refunds of franking credits of $23,000 over the last two. That allows me to spend about $15,000 on charitable activities per year but that does not make the present system reasonable or fair.

Up until the early eighties my wife and I raised five children on a single salary on a marginal tax rate of 66 cents (the then maximum). The marginal tax rate for such a position, now with a much inflated income, is now about two thirds of what I paid then.

Competition from the wealthy, overpaid professionals and executives seeking bricks and mortar securities for their excess income forces up house prices , increases the number of renters, and consequentually force up rents. Our politicians are either deluded, easily deceived, or duplicitous.

<Here were hundreds of students who actually understand that government creates many of the problems, and freedom—personal and economic liberty—makes things better.>
http://reason.com/archives/2011/03/31/students-who-get-it

<Put the smartest people in a room, give them enough taxpayer money, and they will fix most everything.>

Yeah right.

If negative gearing goes,houses won't be built unless Govt gets its greedy hands out of the house market.38% of house/land is Govt taxes and charges

What we need is a new Govt Bank that can create new money that equals growth debt free.Old money will still have a price.Banks should not be allowed to counterfeit our currency.They should only loan out the money they have.

Severe austerity will not improve our economy Saul.It just puts the wealth into the hands of even fewer,with a shrinking economy.

Great article, Saul Eslake. When our property bubble bursts shortly, storys will abound in the media as to why it happened. Your true life story - that our tax regime says "Stop working!" to employment and industry and "Go for your life!" to real estate speculators - is likely to go missing, however. There's a whole lot of inertia out there on this revenue system which is sending all the wrong signals.

ficklepicle - if people can pay back loans, with rent AND some of their own money - then why is lending irresponsible?

The bank gets their loan repaid. That;s what they care about.

Does anyone suggest the investment property market is tanking?

no of course not, people who own investment properties usually work pretty hard to buy them and keep them.

There is a point where the rent is greater than the repayment, and if you've bought sensibly, then that time is somewhere within 10 years of the purchase of the investment property, depending on where you buy and its attractiveness.

You can either then bank the difference between rent and repayment, or keep the property until you wish to sell it and cash in, then you pay capitol gains tax.

People do the sums and get involved or not, you can go spend the money on new TVs and overseas trips, whatever you like and some people wish to invest for their future.

Why is investment property seen as such an evil?

I don't think you understand what goes on in the property investment market at all.

Most people try to get their investment property positive as fast as they can, all the doom merchants work on the theory you buy a property for as little as possible then maximise your negative gearing for a loss you can offset against other gains. That's the corporate, not private investment model.

That's not the way everyone does it, so it's horses for courses.

I know lot's of property investors who either have paid off their investments or have them neutral.

How is a "bubble" applicable to them?

I commend you on this article,Saul. These regressive forms of tax deductions for speculation have angered me for years. Small wonder we have the housing bubble and miserable situation for those who want to buy their first home but have no chance of doing so. It is a national shame that these young people must pay for the excesses of the rich and greedy. Tax deductions for saving would make much more sense.

Loan interest tax deductions for productive investments such as businesses that produce goods or services are are of course legitimate business costs and no-one would against this.I acknowledge that investement properties are also rented and that rental is a business; I have a rental dwelling myself but did not use negative gearing to aquire it. Some deductability may be arguable but at most it should be confined to the actual dwelling; that proportion of the loan that is the deemed replacement value of the residence itself (deemed value on a sq m basis). For example if a property was worth 500,000, house worth 200,000 and land 300,000 then perhaps 2/5 of the interest on any mortgage on that property may be justifiable as tax deductible. Personally, I would not support this but it is an arguable compromise position

A question though, would those making money out of these tax deductions outnumber those wanting to save and buy their first home? It would be worth trying to find figures for this; I reckon first home aspirers would be a large, increasing subset of the population.

Also, I would assert that when our housing bubble bursts (as it will have to do and has already started to), those who have taken out big mortgages will have to wear it though it will be terrible for some first thome mortgagees. The banks, whose lending is 50 - 60% for residential property will also be panicking. But should they not also wear it by reducing their obscene profits for a while? Do these institutions want to be molly-coddled indefinately so they only experience ups and not downs?

Dear Saul,

Thank you for responding to the call to tilt your lance at the negative gearing dragon. A well written piece with some sobering facts.

The section that most astounded me was;

“In 1998-99, when capital gains were last taxed at the same rate as other types of income (less an allowance for inflation), Australia had 1.3 million tax-paying landlords who in total made a taxable profit of almost $700mn. By 2007-08, the latest year for which statistics are presently available, the number of tax-paying landlords had risen to 1.7mn: but they collectively lost more than $8.6bn, largely because the amount they paid out in interest rose more than fourfold (from just over $5bn to more than $20bn over this period), while the amount they collected in rent ‘only’ slightly more than doubled (from $11bn to $24bn), as did other (non-interest) expenses.”

The obvious question was why, if we only have slightly under a third more landlords, and the interest rates of 1998-99 had effectively halved by 2007-8, are they now collectively paying four times the interest? Is that purely the fact that housing prices have gone up so much? Or is much of it due to existing landlords increasing their portfolios?

To go from a profit of $700mill to a loss of $8.6bill in ten years! Wow. To have returns so divorced from expenses screams bubble in my language, one that is only propped up by government largesse to the high middle to upper classes. One might argue that the policy was designed to get more people into the landlord sector but taking into account Australia's population growth over the period all this revenue foregone has only amounted to a 20% increase in its size.

Why do we put up with a tax regime designed to strip so much from our tax base, to so pull out of kilter its progressive nature, and to so hyper-inflate our housing market? Time for some responsibility to be shown by those in power.

What you say about the treatment of saving is correct. All investment be it bank savings, purchase of a house shares should be treated the same in terms of taxation. Henry made recommendations but the Govt did pick this up in the 2010 Budget when it introduced changes to taxation of savings with these being entitled to a 50% tax discount on up to $1000 of interest earned.

Negative gearing
• in amongst your stats from 2007/08 you omit that the average tax loss claimed by those with negative gearing is $3,526. This puts things in a different perspective
• "need to treat all investment the same". If negative gearing for property is taken away and maintained for other investment forms this would be a distortion of the investment landscape and result in a resource misallocation
• you suggest that the decision to invest in housing is based entirely on negative gearing. Not true. You can have all the negative gearing in the world but unless house prices improve you are doing dough. In other words the decision to invest in housing is based on the expectation of appreciation not negative gearing
• I do not agree with your analysis on the market response to the temporary withdrawal of negative gearing during the Hawke Government. To say that rents only increased because of low vacancy rates in certain capital cities is not the correct approach. You would need to compare the change in vacancy rates in all capital cities from before the Hawke Govt action to that just before abolishing the arrangement to judge the extent of the exit of investors. In any case the vacancy rate is the result of demand and supply and the Govt’s decision impacted only on the supply side. You would need to look at whether demand conditions also changed in the capital cities to be definitive about the impact of negative gearing. Most analysts say that the abolition of negative gearing reduced the supply of rental housing.
David Airey
President Real Estate Institute of Australia

"Why do we put up with a tax regime designed to strip so much from our tax base, to so pull out of kilter its progressive nature, and to so hyper-inflate our housing market?"

It is in the very nature of a so-called "progressive" tax system to produce these perverse results.

The reason is because, under the income tax assessment act, tax is levied not on total income, but on income after deductible expenses.
Some businesses, such as supermarkets, may have net profit margins of only a few percent. Let's say of 100% of business income, 95% percent goes to pay overheads, and 5% is net profit. Obviously, the gross income could not be taxed, or the entire economy would collapse. Only net income - income after allowable expenses are deducted - can be taxed. Politicians aren't allowing this margin because they are trying to favour the rich; they are doing it because a successful parasite does not destroy its host.

But because the whole idea of progressive taxation is to tax higher earners more, the obverse also follows - the richer qualify for tax deductions in proportion to the higher proportion of their incomes that are taxable. The effect is to skew the entire tax system, and the economy, in favour of exemptions from tax unequally in favour of the rich; precisely in the proportion in which the tax system tries to screw them. Poetic justice.

This isn't *despite* the progressive tax system. It's *because of* it. Politicians can't fix the problem. They're the ones who are causing it!

One of the reasons why housing is so popular as an investment vehicle is because it's politically difficult to tax, while you would need rocks in your head to try to get rich from other kinds of productive activity, which are over-regulated and taxed to the max.

So spare us the idiocy of complaining that the tax system doesn't favour the poor enough.

Any way you look at it, the solution is to radically cut back on taxes, not increase them!

Stop proposing new taxes, what are you guys, crazy?

040411

Foyle,

if you were to find that the large income from speculative operations were to hurt your conscience and the Charitable Institutions who benefit of your munificence were just cows getting fatter and fatter on the pure pretension of helping the needy, where would you be?

I know of these cows. Last time I counted them their number was six hundred and forty three and growing.

Some legal firms make their business to see that such institutions grow as, with them, grow legal consultancies and revenues.

I am talking of a peculiar industry of tax evasion that exceeds one hundred billion dollarsper year and is called Charity.

This all happens out sight and minds of Economists like Mr. Eslake

Amicus,

I am pointing out the obvious. If a loan is made where the income generated from the loan is less than the interest and repayments made then that is irresponsible lending and it should be condemning under the Responsible Lending Act http://www.treasury.gov.au/consumercredit/content/legislation.asp

The scope of the legislation specifically includes residential investment properties.

I suggest the banks should look closely at any loans to any so called "investors" to purchase properties where the only way the loan can be paid back is for the investor to get tax relief. Such tax relief is problematic as it could be removed tomorrow with the stoke of pen.

An investor who has trouble paying back the loan from rent can stop making repayments because they could say that the banks should not have given them the money to purchase the property in the first place.

Once the first one of these happens - and it will happen as house prices stop increasing - then banks will be in very bad state because all those investors can plead that the banks did the wrong thing. They will then be able to keep their properties and pay back the loan when they are able to from the rent - and the banks will not be able to force them to sell or to make them pay more off their loans than comes in from rent. They could also claim relief from paying interest on the increase in the loan outstanding.

So the best strategy for an "investor" is to forget about the house repayments except for rent repayments and to pocket the tax relief for their own purposes and not give it to the banks.

If I were a bank I would be very very worried. If I were a property lawyer I would be looking to open up a very lucrative new line of business.

Thank you to the various posters who've made constructive comments on this article thus far. Space precludes me from responding to everyone, so I'm responding to a selected few here.

'Rosa1', aspiring but frustrated would-be first home buyers are a growing section of the population, largely because so many have been 'locked out' of home ownership by misdirected government policies which have served to restrict the supply of new housing and drive up the price of existing housing (of which 'negative gearing' is one, falling into the latter category). Investors do outnumber those who are actually able to enter the market successfully as first-time buyers.

'csteele', the reason why property investors are paying so much more in interest than before the capital gains tax rate was halved is because they have taken on so much more debt. According to RBA data, borrowings by (individual) property investors has risen from $73bn in June 1999 to #53bn as of February 2011, an increase of 384%. This is, in my view, an entirely rational response to policy changes which have made borrowing for property investment far more attractive in after-tax terms than it was prior to 1999.

I need to respond in more detail to the comments of David Airey, President of the REIA, posted by 'DPERTH'.

I can't think of any reason why the fact that "the average loss claimed by those with negative gearing is $3526" puts "a different perspective" on any of my arguments. Multiplied by the number of investors who claim these deductions, it is still a very large loss of revenue which could be applied to more productive purposes (including either adding directly to the supply of new housing, or lowering overall tax rates). And I would not be at all surprised if this "average" (ie, mean) masks a very wide spread of individual results.

I have never suggested that "negative gearing" should be aolished for property investment but retained for other types of investment (as the Hawke Government did in 1986-88). That would, as Mr Airey says, be a "distortion of the investment landscape" and quite discriminatory and inequitable. For precisely that reason, my article as orginially submitted to OLO included a footnote indicating that "negative gearing" should be abolished for all types of investment, not just property investment. Unfortunately, that footnote wasn't published.

I never suggested that the primary motive behind the decision to invest in housing wasn't the prospect of capital gains, ie price appreciation. Of course it is - precisely because capital gains are taxed at half the rate applicable to income from working, and are paid when the asset is sold, not as the gains are accrued. Given this favourable treatment, I can see no valid reason why investors should be able to claim deductions for interest expense at the tax rate applicable to income from working (rather than at the tax rate which applies to the capital gains on their assets); nor have I ever heard advocates of "negative gearing" provide one.

(to be continued)

(continuing on), I stand by my analysis of what happened to rents during the period when "negative gearing" was temporarily abolished by the Hawke Government in 1986-88. If the abolition of "negative gearing" had caused a "landlords' strike", as proponents of "negative gearing" usually assert, then rents should have risen everywhere. They didn't. They only rose in cities where vacancy rates were unusually low - and would have done irrespective of whether "negative gearing" had continued to exist. The implication that what happens in Sydney is all that matters is of course typical of people who live in Sydney; but that doesn't make it right.

Moreover, as I said in my original article, even if it were the case that the abolition of "negative gearing" did prompt investors to sell their properties en masse, would that necessarily be a Bad Thing? It would result in lower house prices, improved housing affordability, increased home ownership rates and a decline in the demand for rental properties, perhaps offsetting any reduction in the supply of them. Obviously one wouldn't want any decline in house prices to occur on the scale which happened in the US, or Ireland - but I think it is drawing a very long bow, given the size of the housing shortage in Australia, to suggest that it would.

Real estate agents make their living from transactions in established dwellings, not from additions to the supply of housing, so I can understand why Mr Airey would want to defend a set of tax arrangements which is conducive to the regular turnover of established dwellings (that's part of his job, and I make no criticism of him for doing it). However Mr Airey hasn't produced any arguments, and nor has any other proponent of "negative gearing", to show that the almost $5bn per annum in revenue foregone from "negative gearing" couldn't be better applied elsewhere.

one wonders what might happen to superannuation funds if negative gearing was done away with. The fees ripped by 'financial planners and advisors'have been a disgrace. Until you snout has been in the public trough it is likely that you have done quite a bit of your money on superanaution while the 'expert'investors still took their cut.

Dear Saul
I am assuming you are suggesting that by removing negative gearing and 'tax write offs' from investors, investing in property is a good thing. I would also assume you would wish to include 'depreciation' on you hit list as well, as this to forms a large portion of the decision making process for investors.

Now you mentioned that the number of investors has increased by some 150% in 12 years or so. 700M to 1.7 million.

Now given that we have a housing shortage, that means regardless of whether or not the home is owned or rented, there is a shortage of houses to 'live in', had governments followed your lead and abolished these write offs you refer to, please explain to me, where would these one million plus families be living now if these houses had not been built, purchased by investors and rented to these one million plus families?

Surely you're not suggesting that either they would have bought their own house, or, that investors would have invested knowing full well that they would have had to pay the 'gap' (losses) with after tax dollars.

Come on, I have more respect for you than that.

Meanwhile, Mums and Dads can buy shares in some risky venture, on the hope that they will strike gold and they to can claim to costs of investing in what must be described as a far riskier investment median.

Another problem with your theory is that if these incentives in property were removed, banks all over the country would simply close the door to most investors.

Perhaps as a renowned economist, your time may be better spent trying to educate people how to better allocate their money so they to can become home owners.

Skeptic,
I avoid all charities except the Red Cross.

Apart form the case mentioned below all my charity contributions go directly to unrelated university students who might otherwise not be able to afford the costs.

I provide substantial support via free transport and home maintenance etc. to a family where a parent has a severe, disabling, health problem. This cost is not tax deductible.

The worst cases of charity status abuse is made possible by including churches among genuine charities. As a companion skeptic I am well aware of the problems caused by government funding of proselytizing among the young.

It is evident from Saul Eslake's figures that the Capital Gains Tax changes implemented by the Howard government turbo-charged the application of negative gearing to the housing sector.

The toxic mix of the two on our housing market and taxation system surely means at least one of them has to go.

The question might then become; Is negative gearing on housing acceptable as a part of the taxation regime without the 50% CGT concessions?

Given the large support for progressive taxation, even among economists (81% in the US, sorry Peter, debate on its merits probably needs its own thread) the following question would be; Which of the two, NG or CGT concessions, is more corrosive to that ethic?

In an earlier thread Saul explained “In the United States, for example, investors in rental property (or indeed in any other asset) can only claim interest expenses as a tax deduction in any given year up to the level of income generated by it (in the case of an investment property, rent net of expenses); any excess has to be 'carried forward' against the capital gains tax liability crystallized when the asset is sold.”

At Jan 1990 less than one in every seven dollars on loan by the banks for houses was to investors. By Jan 1998 it was one in four. After the CGT amendments in 1999 the free-fall continued. By Jan 2004 it was more than one in every three. It was only after the 2007 crash that the trend reversed slightly and the ratio currently sits at one dollar for every $3.25 loaned. Is this really what we want for our country?

All governments during that period have espoused their policies for helping Australians into home ownership, via schemes such as the First Home Owners Grants. It is plain to see these efforts have had little chance against the perfect storm of NG and CGT concessions.

In my opinion, given the figures, both should be abolished and we take the money saved to address our chronic shortage of affordable community housing stock.

If you buy any other major investment for business purposes, negative gearing is standard practise, why should housing differ?

it's been attempted before during the Hawke Gov't I think but did not succeed, and it would be a brave government which could pull that off. It's classic middle class welfare, with the renting class being held hostage by landlords. Cui bono?

In response to "Shadow Minister"'s question, let me reiterate the point which "csteele" quoted for an earlier thread - that interest on borrowings undertaken to finance an investment should be deductible, in any given financial year, ONLY against the assessable income which that investment has produced, with any excess carried forward as a deduction against the ultimate capital gains tax liability, and should not be capable of being used to reduce tax on other income which would otherwise be taxed at a higher rate, in the year in which it was earned. I think it is unreasonable and inequitable for interest incurred on an investment to be deductible at a higher rate than that at which the income produced by an investment is taxable.

Incorporated businesses can of course claim interest expense as a tax deduction, and I am not challenging that. But corporate interest expenses are deductible at the same rate as that at which corporate profits are taxed. And (as I understand it) the owner(s) of a company which makes a loss because interest expense exceeds all other net income can not use that loss to reduce the tax payable on the profits made by another company which they may own. So "shadowminister"'s analogy is misplaced.

I am not sure I fully understand the point "rehctub" (butcher backwards?) is trying to make. However I would point out that the vast majority of properties bought by "negatively geared" investors are established dwellings, not new ones: ie, "negative gearing" does not do anything to increase the supply of new housing (and thus to reduce the housing shortage), any more than the First Home Owneers' Grant does; rather, the primary effect of both is to push up the price of established housing (by allowing those who benefit from either arrangement to pay more for the dwellings they buy than they would otherwise).

I have been waiting for some years to see some indication of intelligence and integrity from the both parties, but it has been in vain. All I can see is stupidity and possibility corruption. The consistent insistence of Wayne Swan and the team to continue with this low top personal tax and low corporate tax has been destroying the economy for the last forty or so years, and was shown by the dive into the “recession we had to have” with Paul Keating about 1985. It has been followed by recessions by John Howard and Peter Costello in the '90's etc, and by Wayne Swan several times since his term as treasurer. Both the parties – Liberal and Labor have been quick to claim “Global economy” for their incompetence, inability to even recognise what and where the problem is, even though Wayne has been told several times. The Global warming issue, is another instance where even if it is actual, I cannot see where the tax intended to be applied, is going to affect any improvement at all, maybe one of your “intelligent” gang can advise me and the rest of Australia. Admittedly, the Liberal party seems to be equally ignorant of the necessities to return Australia to an economical success. We can no longer live in this hopeless tangle of stupidity, and have to look forward for a party with intelligence and integrity, and allegiance to Australia and our people. The obsession of both parties in the export of our non-renewable, non-value added resources with the reciprocal imports of all the goods we used to manufacture in Australia, clothing, tools, cars, even trains, shows that these incompetents are wholly determined in destroying the economy and whatever else still exists in our country. As you might get from this message, I and most likely many more will not be voting any more for either the Labor or the Liberal parties in future elections. I have to wonder how a gang of so called professionals can be so stupid or is it corrupt, maybe it is something they are ingesting.

Merv09 you are right.There is gross corruption and stupidity.Our pollies are selected by the Corporate elites not for their intelligence but their malleability.

see http://www.secretofoz.com/ L Frank Baum in 'The Wizard of Oz' had deep economic meaning for us all.'Secret of Oz' by Bill Still last yr won the Biff International award for best documentary.It looks at the history of money from Roman times to the present and the realistic solutions.

Dear David Aivery,

You said;

“you suggest that the decision to invest in housing is based entirely on negative gearing. Not true. You can have all the negative gearing in the world but unless house prices improve you are doing dough. In other words the decision to invest in housing is based on the expectation of appreciation not negative gearing”

I agree the decision to invest in housing is not always based on negative gearing however I do not agree without house prices improving (and I'm assuming you mean better than CPI) that 'you are doing your dough'.

My wife and I have spent the vast majority of our working lives self-employed. When running small businesses setting up and running a personal superannuation scheme is not always that achievable nor attractive. Buying a rental property that is slightly positively geared and having the renter pay the house off over the loan period with little or no continuing outlay from our selves is on one level a perfectly sound strategy for providing for ourselves in our later years.

However it is not drawing on the public purse through negative gearing nor should it be regarded as speculation.

Granted though it still removes one dwelling from the total available for owner occupation.

The speculation over capital gain windfalls at half the personal tax rate has driven the frenzy of investment in houses and seen the escalation of housing prices way outstripping rental returns. You would know more than I but I am assuming it would be very rare for one to find, at today's prices, an investment property whose income exceeded that of its expenses.

The only thing that now makes the investment viable as a business proposition is the government foregoing some of its income tax base to fund it plus the prospect of capital gains (hardly a continuing certainty). Surely though it should be the business of government to be funding productive enterprises rather than the quite unproductive investments in existing housing.

Just need to pipe in about Peter Hume's post...

'But because the whole idea of progressive taxation is to tax higher earners more, the obverse also follows - the richer qualify for tax deductions in proportion to the higher proportion of their incomes that are taxable. The effect is to skew the entire tax system, and the economy, in favour of exemptions from tax unequally in favour of the rich; precisely in the proportion in which the tax system tries to screw them. Poetic justice.

This isn't *despite* the progressive tax system. It's *because of* it. Politicians can't fix the problem. They're the ones who are causing it!'

That's a great post. I would add that too many investment decisions are influenced by the tax implications. I see it as a huge waste in the economy that the Tax Laws are so complicated, and way too much money is spent avoiding Tax.

' One of the reasons why housing is so popular as an investment vehicle is because it's politically difficult to tax, '

As I was saying above.

Saul,

Glad you agree with me...

'I can see no valid reason why investors should be able to claim deductions for interest expense at the tax rate applicable to income from working (rather than at the tax rate which applies to the capital gains on their assets)'

'interest on borrowings undertaken to finance an investment should be deductible, in any given financial year, ONLY against the assessable income which that investment has produced, with any excess carried forward as a deduction against the ultimate capital gains tax liability, and should not be capable of being used to reduce tax on other income which would otherwise be taxed at a higher rate, in the year in which it was earned.'

Yes! I generally don't understand economics, but in the General forum section I said just that! Well, I wasn't sure if you *could* claim it against PAYE, but I said that if you can, It's a SCAM!

So, since the great Saul agrees with me, I expect an honorary doctorate in economics.

Saul, and many of you, are so wrong.

Investors in housing may be buying existing dwellings, but if they did not then fewer new houses would be built. Simple as that.

Negative gearing fosters more housing investment, by reducing some of the uncertainty, thereby stimulating new building. Banks and others get their bit, and pay taxes on it. Where's the loss?

For negative gearing losses to be held over until a property is sold, is absurd, because:
i) It unfairly penalises investors, including those using it as a means of saving for retirement,
ii) It means an investor is forced to sell to regain losses from negative years, to achieve an effective return. How can that be fair?

Saul, Do I take it you suggest it is ok for an "Incorporated Business" to be exempt from your draconian system; just not small investors??

Saul: A few errors in your arguments:
i) That we only invest in what is certain to make a capital gain - where is there such an assurance? Do housing and share prices never fall?
ii) That capital gain is the driving force - have you not heard of investment for saving, with assets handed on to the next generation?

Your attack on capital gains taxation concessions is also absurd. Such gains will have generally been achieved over many years, but are taxed in the one year of realisation. How can it then be fair to tax these gains as if derived solely in that one year??

IF you really want to do something positive for people saving, Why don't you suggest making savings tax-exempt? Thus making the passage to home ownership a bit easier.

In the U.S. home mortgage interest is deductible. Aren't we hit enough!

"Saltpetre", I respect absolutely your right to tell me I'm wrong; I nonetheless stand by all the assertions I've made in my original article and in subsequent comments.

Australia is one of the few countries in the western world that allows "negative gearing" in the sense that we comprehend that term. In most other Western countries, the tax law allows what I think it should be changed to allow here, namely, deductibility of interest expense on borrowings incurred to purchase an asset up to the level of income earned from that asset in the same financial year, with any excess "carried forward" against the ultimate capital gains tax liability.

Yet despite this much more generous treatment of the costs of borrowing to acquire investment property than other countries, Australia has a substantial shortage of housing relative to the underlying demand for it, whereas countries which aren't as "generous" to investors in this regard, such as the US, don't. Moreover, Australia's shortage of housing has got significantly worse since the tax treatment of investors became more concessional in 1999 (when the capital gains tax regime shifted from taxing real gains at a taxpayer's full marginal rate, to taxing nominal gains at half the full marginal rate).

Hence there is no evidence at all to support "saltpetre"'s contention that "negative gearing" has stimulated increased housing supply. On the contrary, the evidence points to the opposite conclusion. (Note I am not suggesting that "negative gearing" is the only, or even the main, reason for the shortage of housing: other factors, including excessive upfront charges on developers, and unduly restrictive zoning requirements, are also important).

Nor am I suggesting (as "saltpetre" asserts) that investors invest in housing in the expectation of certain or guaranteed capital gains. Nothing is certain: of course share prices (and less commonly) housing prices can and do fall from time to time. However I would confidently assert that investors do expect the prices of the assets they acquire to increase over time. And that is whether they expect ultimately to sell the assets themselves, or bequeath them to their descendants

(continued) And I totally reject "saltpetre"'s assertion that my criticism of the concessional tax treatment of capital gains is "absurd". When else should capital gains be taxed, other than in the year in which the asset is sold? Perhaps capital gains shouldn't be added to other income, thus potentially exposing them to a higher marginal rate (because the taxpayer has other income); but I can see no valid reason why capital gains should be taxed at a lower rate than that which applies to income from working

This post by Saul Eslake has if nothing else opened up debate on a touchy subject, which Govts of all persuasions have been loathe to address. Can I add that I'm a big fan of Eslake economics but I cant let that get in the way of a good debate!

FACT 1: Negative gearing is available to all taxpayers for investment purposes. It is in fact encouraged by accountants/advisers for high income earners to reduce or defer a tax bill.
FACT 2: Real estate agents neither encourage or discourage the practice - its a decision made by the buyer of the property.
FACT 3: New housing starts are down another 10% roughly and that's with the negative gearing option available. Established home sales are down 21.8% on historic averages (note that's sale numbers not prices).

I argue for the retention of negative gearing because there is not a better alternative on offer. This is due to the reluctance of Govt's to do anything serious about the tax system. Anecdotal and historic evidence has shown us that if there is even a hint that neg gearing is threatened then investors take flight. And yes its true to say that the market would then be flooded with properties for sale and when supply exceeds demand, prices fall. Many will argue that is a good thing. I will argue that a flat or collapsing property market will give rise to a serious recession due to the fact that lenders pin all debt back to real property mortgages and reduced values translate into calls for debt reduction and you can see the awful picture that then emerges.
Thanks for the excellent feedback.

SE says>>I am not sure I fully understand the point "rehctub" (butcher backwards?) is trying to make. However I would point out that the vast majority of properties bought by "negatively geared" investors are established dwellings, not new ones: ie, "negative gearing" does not do anything to increase the supply of new housing (and thus to reduce the housing shortage),

Well not quite true. The sellers of the 'old home' in most cases upgrade to a new home. Now if they buy another established home, then somewhere along the line, someone buys a new home.

Furthermore, are you trying to tell me that all of these rental units, being built in their tousands are for 'owner occupiers' and not investors. Yea, right!

The simple fact remains that if you take away the incentives for inestors to invest, then they stop investing. End result, an even worse housing shortage than we already have.