Grattan's John Daley: Sorry Malcolm, you are wrong
on negative gearing
Turnbull's negative gearing claims
under fire by John Daley
The Prime Minister, Malcolm Turnbull, yesterday wrote a detailed
blogpost in reply to our report, Hot property: negative gearing
and capital gains tax reform. It's good that a Prime Minister engages with the
detail of policy argument rather than responding with slogans. But none of his
criticisms stick.
Generally accepted principles
First, he argues that negative gearing is part of
generally accepted principles for offsetting losses against gains. Negative
gearing has indeed been permitted in Australia for over a century. But this
"generally accepted principle" is not accepted in most developed
countries, and it is far from being universally applied in our own tax and
welfare system.
As our report documents, we could find no developed
country save for New Zealand that allows taxpayers to deduct the interest
costs of investment from their wage and salary income. And Australia imposes
tight limits on claiming the losses from a business against labour income, as
the Prime Minister notes. Losses from investment are also not counted when
assessing income to determine eligibility for welfare payments.
Housing market distortions
Second, the Prime Minister argued that Grattan's
report contradicts itself in claiming that tax arrangements
significantly distort the housing market, while calculating that
changes will only reduce housing prices by about 2 per cent. The explanation is
simple: a new tax regime will significantly affect on the mix of investment,
but have less impact on the total.
Tax changes would lead to more home ownership, more
investment in assets other than property, less investor leverage, and increased
tax collections of about $5 billion a year. By themselves, tax changes cannot
solve Australia's problems of housing affordability, high private sector borrowing,
and Commonwealth budget deficit. But they would all be steps in the right
direction.
Fairness
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The Prime Minister is concerned that changes will not
be "fair" because they will lead to fewer
middle-and-low-income earners borrowing to invest. This might well be true. But
tax reform should proceed anyway. Although investors with only one asset will
not be able to offset their losses against gains on other assets, overall the
reforms will affect high incomes earners far more. The top 10 per cent of
taxpayers before rental deductions get half of the benefits of negative
gearing. By definition, they make losses on their collective investments.
Reform cannot help but create a fairer system. And there will remain plenty of
ways for low-income earners to invest without negatively gearing property.
Capital gains discount
Fourth, the Prime Minister is concerned that reducing the
capital gains tax discount to 25 per cent would give Australia a
high capital gains tax rate relative to comparable countries. He claims this
would have "harmful impacts". We don't know what evidence he has in
mind. But a substantial body of literature, including an OECD report, finds
that tax rates have little impact on how much people on high incomes invest.
Even the government's own Re:think paper on tax
reform says that while "low-income individuals may respond to tax
incentives with new saving, high-income individuals are more likely to divert
savings to more tax-preferred savings". It concludes that, "although
taxes may affect the allocation of savings, they are unlikely to affect
significantly the overall level of investment in the economy".
Choosing assumptions
Fifth, the Prime Minister is concerned that with a
reduced discount, the effective tax rate on real capital gains would be close
to 70 per cent. This is an issue that our report works through in detail, and
it all depends on what assumptions you make, bearing in mind that tax is not
paid on capital gains until the asset is sold.
Under a capital gains discount of 25 per cent, as
we propose, and with inflation at 2.5 per cent, an asset held for fifteen years
with a 3 per cent nominal income return and 4 per cent capital return would pay
a real effective tax rate of about 55 per cent if the taxpayer is one of the 3
per cent of Australians on the top marginal rate.
The effective tax rate would be much lower if
capital growth is higher than 4 per cent – and capital growth on Australian
property has averaged 7 per cent over the last 15 years (a table at the
back of our report enables readers to mix and match assumptions).
Increased taxes?
Finally, the Prime Minister is concerned that
removing negative gearing would increase the effective income tax rate for wage
and salary earners, reducing the incentives to work. But using negative gearing
seems a strange way to solve this problem. Why would we try to reduce marginal
income tax rates, but only for the minority of workers who happen to invest?
What's more, income tax rates need to be higher across the board to pay for the
tax break we provide to one in 10 taxpayers.
The Prime Minister then uses our calculations to
argue that removing negative gearing would reduce gross rental income by about
10 per cent. But he is looking at gross rental returns, which is the wrong
number. Investors worry about their return after tax, including their capital
gain. This return will fall by less.
Having made this error, the Prime Minister then
simply asserts that this change in returns will increase rents. No study of the
real world has ever found tax changes with this impact. Instead, in markets
where property development is limited by planning permissions, changes in
returns typically reduce property prices. Again, this is an issue that our
report works through in detail. Nor is it plausible to claim, as the Prime
Minister does, that the removal of negative gearing caused rental crises in the
UK and US. Any number of countries that do not allow negative gearing have
functional rental markets.
Engaging in detailed argument ultimately leads to
better policy. We look forward to the Prime Minister arguing back – and maybe
even changing his mind.
John Daley is CEO of the Grattan
Institute AFR Contributor
This story has been brought to you by the Emerald Chamber of Commerce Inc.
(Ph: 07 4982 3444)
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