Negative Gearing: Incompetence Or Conspiracy?

A rental property is said to be negatively geared if the owner’s expenses (including mortgage interest and maintenance) exceed the rental income, so that the property makes an annual loss. If the tax system allows negative gearing deductibility, that loss can be deducted from other income for tax purposes. Abolition of this deductibility, loosely known as “abolition of negative gearing”, would make the owner’s expenses deductible against the rent alone — not against other income.

SPIN: Negative gearing deductibility helps renters and first home buyers by encouraging property investors to “supply accommodation”; the larger the supply, the lower the rents and prices.

FACT: The only investors who actually add to the supply of accommodation are those who build new accommodation. Therefore, if negative gearing deductibility were really intended to maximize the supply of accommodation, it would be allowed only for new construction — not for future purchases of established properties. But in fact the negative gearing rules fail to distinguish between new and established properties, giving no incentive to build rather than buy. So the supply of accommodation is lower than it could be, and rents and prices are consequently higher than they could be. That’s good for current owners of rental properties, but bad for renters and first home buyers.

VERDICT: Negative gearing deductibility could help renters and first home buyers if it were done properly. But it isn’t. It’s done so that established property investors get a tax break at the expense of other taxpayers plus higher rents and prices at the expense of renters and first home buyers.

15 Comments

  1. alan lewis25-02-2008

    Dr.Putland

    Your short article ‘Negative Gearing – Incompetence or Conspiracy’ is the best succinct description of what is causing the housing affordability problem in Australia.

    It appears to me that a sort of covert neo-feudalism is sucking the life out of the next generation.

    I have written a parody of the situation that you might enjoy reading if you have 5 minutes free.
    The address is –
    http://zzalanz.googlepages/home
    then go to investorsruleok

    I am doing what I can do to embarass the architects of this problem (Treasury) into action.

    Any suggestions as to how I can help curtail the monster in our midst would be greatly appreciated.

    Alan

  2. alan lewis25-02-2008

    Dr.Putland

    Just realised the parody address was incorrect.

    The address should have read –
    http://zzalanz.googlepages.com/home
    then go to investorsruleok

    Cheers
    Alan

  3. Rick10-09-2008

    Who determines this is fact and on what basis?

    FACT: The only investors who actually add to the supply of accommodation are those who build new accommodation. Therefore, if negative gearing deductibility were really intended to maximize the supply of accommodation, it would be allowed only for new construction — not for future purchases of established properties. But in fact the negative gearing rules fail to distinguish between new and established properties, giving no incentive to build rather than buy. So the supply of accommodation is lower than it could be, and rents and prices are consequently higher than they could be. That’s good for current owners of rental properties, but bad for renters and first home buyers.

  4. Rick10-09-2008

    Its the supply of Accommodation for Rental Purposes & not Accommodation overall why the govt provides negative gearing assistance.

  5. Gavin R. Putland12-09-2008

    Dear Rick,

    Investors who buy existing homes don’t add to the overall supply, but merely turn homes for sale into homes to let. This does NOT address the shortage of rental homes, because the reduction in the supply of homes for sale throws potential owner-occupants onto the rental market, so that the increase in supply of rental homes is offset by increased demand. If you really want to address the shortage of rental homes, you have to address the OVERALL supply, not just the supply of rental homes. But if you only want to PRETEND to address the shortage of rental homes, the existing negative regime is a great way to do it. That’s why it’s so firmly entrenched.

  6. Gavin R. Putland12-09-2008

    Correction: “existing negative regime” should have been “existing negative gearing regime”. But it is indeed a negative regime.

  7. Steven Shaw14-03-2009

    My understanding is that many countries have legislated against tax incentives for negative gearing. The US even allows a tax deduction for owner-occupier mortgage interest I think. The UK used to have that but doesn’t any more.

    I don’t own a home and am waiting patiently (and otherwise) for the prices to come down. No doubt they will and soon.

    I have a friend who using NG on a property he bought to give a home to his mother. He was very angry when I mentioned that there seems to be a groundswell of support against NG. He mentioned that if a company is allowed to offset all revenues against expenditures when it calculates profits for tax purposes. Why should it be different for individuals?

    What he said makes a lot of sense to me.

    We have other policies that have contributed to the house price bubble: NG, 50% discount on capital gains tax (2001 I think) and FHOG (began in 2000 and increased in 2001 and 2008 I think). Reducing tax seems like a good idea. Offsetting revenues against expenses (NG) seems to makes sense.

    Perhaps the main problem is central banking. Artifically low interest rates and the massive expansion of credit which has sunk billions into property and shares in the last 10-15 years.

  8. Gavin R. Putland16-03-2009

    Steven Shaw’s friend protests: “… if a company is allowed to offset all revenues against expenditures when it calculates profits for tax purposes. Why should it be different for individuals?”

    The question is a red herring: nowhere in the above “talking point” (or anywhere else) have I suggested that the negative gearing rules for companies should be any different from those for individuals. I am, of course, sympathetic to tax reforms that would render the whole concept of negative gearing meaningless. But as long as negative gearing means something for both individuals and companies, the rules should be the same for both.

    Mr Shaw correctly blames the FHOG and capital-gains discounting for some of the inflation of home prices. But if these concessions were made contingent on building a new dwelling — as I have suggested for negative gearing — they would help to expand the stock of housing instead of inflating prices of the existing stock.

    Yes, expansion of credit has been a problem. But credit is expanded against collateral — chiefly real estate. Therefore, by directly attacking real-estate bubbles, you can help to prevent unsustainable expansion of credit.

  9. Steven Shaw15-04-2009

    The question is a red herring: nowhere in the above “talking point” (or anywhere else) have I suggested that the negative gearing rules for companies should be any different from those for individuals.

    Hi Gavin, I didn’t mean to suggest that you had said that the NG rules should be different for individuals or companies. I was just relating a story about my friend. At the time of this conversation with my friend I saw NG as certainly one of the catalysts for the current housing messing Australia. My friends comments made me feel that outlawing NG on housing would be wrong. The trouble is though that we have all these incentives (government subsidisation) and easy credit. That will probably change but with interest rates what they are now it may not for a while. People still feel that Australia is “different”. It’s a sad thing. I guess Australia is different in that we have NG. I’ve heard that no other developed nation has it. In America it has been legislated against specifically for the property market though I believe.

    Yes, expansion of credit has been a problem. But credit is expanded against collateral — chiefly real estate. Therefore, by directly attacking real-estate bubbles, you can help to prevent unsustainable expansion of credit.

    It’s a chicken-egg problem. Did the credit expansion cause the housing boom or did the housing boom cause the credit expansion. I for one need more information but my feeling is that the credit expansion leads to money that has to go somewhere! In this case (as it usually does in recent times) it went into property and shares. If we outlaw housing booms, and still allow massive credit expansions, won’t the new money just go somewhere else? Shares will still boom. Perhaps tulips or something ;). This is why I currently favour the Misean/Rothbardian explanation of the business cycle.

    I can imagine how a land tax as advocated by George would mean less trouble for the working class during a credit expansion however. I think Milton Friedman called it the least evil tax.

  10. Gavin R. Putland15-04-2009

    Steven Shaw wrote: “If we outlaw housing booms, and still allow massive credit expansions, won’t the new money just go somewhere else? Shares will still boom.”

    Yes. But if some or all existing taxes on listed companies were replaced by a holding tax on shares, proportional to the above-par component of the share price, that would tend to smooth out share prices around their long-term trends, avoiding bubbles, bursts and overshoots.

    If assets in a certain class can be produced by competitive effort, you can’t have a bubble in that asset class, because prices are limited by production costs; if prices were to rise substantially above production costs, or if earnings were to rise substantially above a fair return on production costs, more production of such assets would be induced, and the competition from the new assets would counteract the rise in prices or earnings.

    So the assets that are susceptible to bubbles are those that CANNOT be produced by competitive effort. Land is in that category, as are shares to the extent that they are backed by land and other non-replicable assets. (Shares are also land-like in the sense that the supply of shares is inelastic in the short term: the creation and destruction of shares is very slow compared with trading in existing shares.)

    If we attack credit expansion per se, we inhibit not only speculation in assets that are susceptible to bubbles, but also the creation of new assets that are needed for productive purposes. So we need policies that discriminate between the two classes of assets.

    The Georgist response is: Because governments have to get revenue from SOMEWHERE, let’s build the necessary discrimination into tax policy.

    One could, no doubt, discriminate by other means, e.g. by credit regulations that discriminate between classes of assets used as collateral, or by restrictions on ownership of assets that are susceptible to bubbles (e.g., the Old Testament law provides that land reverts to its original owner every 50 years, and Steve Keen has proposed a similar system for corporate shares).

    But the weakness of these alternative approaches is that they leave in place the present tax system, which penalizes productive activity and imposes excessive compliance costs. Using tax reform to unburden production and suppress speculation solves both sets of problems.

  11. Steven Shaw17-04-2009

    Yikes, the solution is another tax :(

    Instead of a myriad of tax policies to deal with asset bubbles, I still prefer fixing the problem at the root. The easy credit. Those tax policies you suggest are fraught with danger and open to manipulation through political lobbying. People would constantly be calling for the “share tax” to be increased or decreased depending on whether they owned shares or not (assuming they aren’t saints).

    A Rothbardian “sound money” solution to the easy credit problem also puts the inflation genie back in the bottle. This has the nice affect that it would allow people to save for retirement safely (without speculating on shares). Their money would, of course, be used by others as loans to purchase houses etc. Not sure if it deals with banks borrowing money from overseas specifically. I guess that’d be ok if it were also “sound money”.

    I’d be happy to see the kind of loans called for in the Bible too. They are cancelled after or on the 7th year. Of course, this would be up to the creditor and debtor to sort out in their initial contractual agreement. I’ve always thought that if I bought property, I’d plan to pay it back in 5-10 years.

    I’m not so familiar with the 50 year jubilee though I happened across it recently too. It sounds interesting. How’s it supposed to work? Who’d you give the land back to?

  12. Gavin R. Putland28-04-2009

    I wrote “… if some or all existing taxes on listed companies were replaced by a holding tax on shares…” and Steve Shaw responded “Yikes, the solution is ANOTHER tax” (my emphasis). So how many existing taxes does a new tax need to eliminate before it ceases to be just ANOTHER tax?

    Yes, tax reforms are liable to be overturned by self-serving lobbying. So are reforms designed to eliminate easy credit.

    To whom would the land title revert after 50 years? How about the State? If the State got its income from assets, it wouldn’t need to impose those taxes that Rothbardians find so odious. Rothbardians apparently consider it virtuous for retirees to support themselves by deriving income from assets instead of burdening the taxpayer. Why shouldn’t governments do the same? Is a private virtue a public vice?

    And how would the State legitimately acquire the title after 50 years? Perhaps by making some grant or tax concession contingent on a reversion of title. What? — you’d rather keep the title forever? Fine — you don’t get the grant or concession. Far be it from me to abridge your freedom of choice.

    But, now that I’ve mentioned tax concessions, perhaps it would be simpler to do everything by straightforward tax reform.

  13. Steven Shaw18-05-2009

    Hi Gavin, fair point about the “tax reform” isn’t exactly the same thing as a “new tax”.

    How do we decide on the justice of one tax over another (even in tax reform on shares)?

    Isn’t all lobbying self-serving?

    Gavin, you have a lot of trust in the State. This is the State who keeps the easy credit flowing, the state that panders to the building lobby (and others) by introducing and increasing the FHOG, a state that has increased spending over the boom times and now refuses to decrease spending in line with the recession and reduced income, a state who in fact is increasing expenditure via debt to gamble away our futures. You trust could be misplaced.

    You asked “Is a private virtue a public vice?”. Of course the answer is no – virtue is universal. As it is prudent for an individual to avoid excessive debt so it is prudent for a group of individuals. As it is unjust for an individual to steal another’s property, how can it be made just for a group of individuals?

  14. Gavin R. Putland18-05-2009

    Dear Steven Shaw,

    Which of my proposals show my alleged excessive trust in the State, and how do they require more trust in the State than your proposals, whatever they are?

    Which of my proposals allegedly involve a group of individuals stealing the property of one individual, and by what action did that one individual allegedly acquire a just title to the allegedly stolen property in each case?

    But before you can explain how your proposals allegedly respect property rights better than mine, you’ll probably have to explain the moral foundation and social utility of property rights. Your answers might reveal which of us really has more faith in the State.

  15. Steven Shaw29-05-2009

    Hi Gavin!

    I said you appeared to have a lot of trust in the state. You asked which of your proposals show excessive trust in the state. This was when you said:

    To whom would the land title revert after 50 years? How about the State?

    You also asked:

    … and how do they require more trust in the State than your proposals, whatever they are?

    I haven’t made any proposals that I recall. I am studying with much interest the work of Murray Rothbard and others: a free and stateless society based on natural rights of self-ownership and private property.

    Which of my proposals allegedly involve a group of individuals stealing the property of one individual, and by what action did that one individual allegedly acquire a just title to the allegedly stolen property in each case?

    Gavin, I did not allege that one of your proposals involved theft! However, you seem to be well aware that it does :). You were the one who asked “is a private virtue a public vice?”. I was merely pointing out that if you agree that virtue is universal, then excessive debt and stealing of property to be avoided for private persons as well as the public/state.

    But before you can explain how your proposals allegedly respect property rights better than mine, you’ll probably have to explain the moral foundation and social utility of property rights. Your answers might reveal which of us really has more faith in the State.

    As you probably have already gathered, I do not place my faith in the State. I am really early in my journey into the study of political philosophy. My understanding is that private property derives from natural rights. It’s also a common understanding for those with a Judeo-Christian upbringing. It’s perhaps more widespread than that but I’m not sure.

    I’m not sure what you mean by social utility.

    Your thinking on property rights seems to be that the government owns everything and that we should all rent off it. Would you critique my view of your view and provide a moral foundation for your view of property rights.

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