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Let's take a look at the economic consequences of negative gearing being abolished.

Should negative gearing be abolished? Here's my view

Peter Switzer
15 May 2016

By Peter Switzer

As countless political surveys of us Aussies tell us that we care about the economic offerings of our politicians most, I thought it was time to give you an objective economic analysis of negative gearing.

The issues are so numerous, I’ll have to analyse this topic over a few days. Today, here’s my high level view of what Labor’s changes to negative gearing and the capital gains tax discount might mean. The Coalition has no proposals to change negative gearing or capital gains tax.

A lot of what I’ve been hearing from the Coalition, Labor and vested interests has been political, so let’s look at the certain and possible economic consequences of Labor changing the ground rules for negative gearing.

In case you don’t understand what negative gearing is, let me give you a simple explanation.

Let’s say you pay a lot of tax so your accountant or adviser says: “Why don’t you buy an investment property?” Obediently, you buy a place where the interest repayments plus other costs, such as agent’s fees, repairs, etc., are $1000 a month. Meanwhile, the rent from the property gives you $800 each month. You lose $200 a month or $2,400 a year.

What happens next? First, you can deduct this loss from your income, which reduces your taxable income, which could lead to a tax refund. You can actually work out this potential amount and get your paymaster to adjust your fortnightly tax on your salary. 

Second, if you hold the property for a while, you should also get some capital gain, which you’d pay tax on. If you hold it for more than a year, the tax is discounted by half.

Labor proposes to restrict negative gearing to new properties, while permitting those who have a negatively-geared property to keep playing this game. However, if they try and sell their property, it could be sold for less than it would have, if other investors were able to buy it, keep renting it out and take advantage of the ‘old’ negative gearing.

You don't have to be an economist to work that out. Less buyers and less well-heeled buyers with a tax concession under their belts means property price rises should be slower. And given what your property might be worth now, it could easily fall in value.

Putting another reason to bring house prices down at this time in the housing cycle might not be the cleverest idea. This might have been better timed when Julia Gillard was PM and this might have hosed down the terrific price rise over the past three years. That said, it would have made Perth’s post-mining boom housing challenges a damn side more ugly.

On the other hand, Labor’s support for new homes and negative gearing should be good for housing construction, as investors would want to buy these sorts of properties. Once again, however, they wouldn’t be prepared to pay top dollar because when they come to sell the property, there won’t be investors wanting to buy them because these properties won’t be ‘negatively gearable’, if such a term exists.

Remember, investors want tax deductions, income and capital gain. If these new properties promise less returns, investors might look to shares and other assets.

I think the policy will slowly bring house prices down for new home buyers or upgraders, who want to live in homes now owned by investors, though investors might just hang on to their properties because they have that special negatively geared status. 

Many will gamble that a Coalition Government of the future would reverse Labor’s negative gearing proposals and that could keep them in the landlord game.

Some experts argue that a lower capital gains discount of 25%, rather than the current 50% after holding an asset for over a year, could lead to more gearing or borrowing to offset the lower tax pay off.

Charles Tarbey, the founder of Century 21, who has a vested interest to not like the changes, says he’ll make money any way because there’ll still be buyers of property. He concedes, however, that the price rises will be less so there’ll be less profits. However, he says there are a lot contractors or service providers who work for landlords or their agents in maintaining these investment properties so there’ll be a lot of job dislocation.

An economist would argue that other work will show up elsewhere and some businesses will lose customers, while others will gain them. The question is: is this the right economic time to throw a spanner in the works of the housing sector?

Housing has been one of the savior industries, along with tourism and education that have come to the fore with the mining boom petering out. Labor opted for a mining tax, as the mining boom was on the slide and now we have two housing curve balls, just when house price rises are already starting to come back to more normal levels.

It always worries me when I think of Paul Keating and his 1985 ending of negative gearing, which he reversed in 1987. Often what looks good on paper and in theory doesn’t work out the same way in the real world.

There’s a lot of academic analysis by theoreticians, which I’ll look at in coming days but their conclusions rest on some questionable assumptions. That said, they may be right, they may be wrong or they may be crazy.

We know Labor wants to change negative gearing and the capital gains tax discount to reduce losses to Treasury. Negative gearing and capital gains tax concessions will cost the budget over $10 billion this year, Chris Bowen tells us.

So there’s good reason to eye off these incentives for investors to borrow to invest, encouraged by a tax incentive. However, when you close one door, an investor doesn’t simply say “Oh well, bad luck, I better play the game like everyone else”. No, they’ll look for alternative strategies. These alternative decisions by investors and the losses that can follow elsewhere in the economy when a Government changes the rules, can sometimes be desperately underestimated by experts ahead of the change. The Keating reversal is a case in point.

First home buyers find new properties expensive because state taxes and other slugs on developers push up new home prices by 30% plus but no Federal Government ever wants to take on that stupidity.

This negative gearing issue is a huge debate for the election. Thank God I have seven weeks left to work out whether it’s a good idea or a dud.

If you liked this article you'll love the Switzer Report, our newsletter and website for trustees of self-managed super funds. Click here for a FREE trial and to hear more of Peter’s expert commentary and advice.

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