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.