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.