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.