Six Factors to Flip Negative Gearing into Negative Equity – Someone’s Going to Get Hurt

 

The Australian Tax Office has released figures on the extent of negative gearing in Australia ahead of the Henry Tax Review.

This is no accident. They are preparing the ground for Ken Henry’s changes.

The picture drawn is not pretty: it shows the nation’s ‘aspirational’ landlords, heavily weighted with borrowings, perched on a twig, waiting for the tree to grow under them.

2005 2006 2007 2008
Number of landlords

1,495,646 1,543,310 1,592,636 1,705,683
With >1 property n/a 409,222 424,452 456,956
Rental income $17.653bn $19.16bn $20.911bn $24.12bn
Deductions $21.753bn $24.29bn $27.283bn $32.75bn
Net Loss -$4.1bn -$5.088bn -$6.372bn -$8.63bn
Rise in interest costs 20.3%

14.1% 16.4% 25.6%
% making a loss 65.4% 66.5% 67.9% 69.4%

Source: ATO

The ATO says people earning between $30,000 and $75,000 represented the largest group of taxpayers who held property investments and they claimed $3.6 billion in losses.

Given the general low level of financial literacy, I do not accept all these wannabe landlords fully understand how precarious their position is. The low and middle income earners among them are dangerously exposed. In short, 1.3 million individuals could fall to earth if any of the following – completely independent – events occur:

• A significant rise in interest rates. The Reserve Bank is determined to return rates to ‘normal’ levels in the immediate future. Private bank economists’ rate predictions are even higher as domestic demand must be displaced for the coming resources boom.
• Prolonged rental vacancy. Vacant retail and industrial properties can take time to let and tenant incentives may be needed; residential properties are easily damaged by feral tenants – leading to simultaneous capital spending and nil income.
• Landlord unemployment. Negative gearing means interest payments are subsidised by other income. If this income stops for any reason, the bank will call in the mortgage, especially if the property is thinly capitalized.
• An end to negative gearing. Ronald Reagan, pin-up boy of the conservatives, did just this in the USA. And the release of this table before the Henry Review is made public signals the same for Australia.
• Falling property prices. The GFC drove land prices down in the USA, the UK and in Europe, destroying the futures of millions of people. Australia’s First Home Vendors’ Boost and mild recession have stopped this here… so far.
• State land rezoning. Governments have been very disciplined in restraining the sprawl of our cities by tight restrictions on turning rural land into urban. With younger people furious at being locked out of home ownership except at crushing prices, politically motivated zoning changes could increase residential land supply at the stroke of a pen.

In fact, our small landlords are betting – and multiplying their risk with heavy gearing – the bubble will continue and NONE of these risks emerge.

This commentary is not about winners and losers or opportunity and resentment. The real and enduring problem is distorted investment incentives.

Negative gearing is only one of many factors deflecting savings from investment in productive activity to amassing and hoarding of land – which is ‘beggar thy neighbor’ behavior. This is contrary to the public interest and reduces our productive capacity.

The grim and headstrong pursuit of the fabled ‘unearned increments in wealth’ can be stopped by the Henry Review with a Federal Land Tax. Before you recoil from ANOTHER TAX! – consider that this could lead to the repeal of up to 125 other taxes, many of them regressive, easily evaded and subject to cost shifting.

A new tax system? I’d like to see that!

4 Comments

  1. Bernard Rooney02-04-2010

    A land tax is fine, although personally I would prefer if it were at lower levels of govt, ie State and Local Govt.

    They are the ones about which it is constantly said they have limited sources of revenue.

    But how are you going to spend this money?

    What about a citizen’s dividend, or a hypothecation of the revenue to physical infrastructure, or to development of renewable energy?

    People are not as much interested in taxing as much as they are in spending.

    The georgist emphasis on the glories of tax is frankly odd. (I know this comes from George himself).

  2. David Collyer06-04-2010

    Georgists believe Land Tax should be levied by all levels of government, and the funds used to remove other taxes – most of which are regressive, behavior-distorting, expensive to collect and plain unfair.

    This is not about raising the government’s share of GDP, but about taxing the bounty of nature rather than labor or capital.

    Our mineral wealth could be captured and used – like Norway’s – for a citizen’s dividend or physical and social investment or all three.

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