Saul Eslake at the 122nd Henry George Commemorative Dinner

Saul Eslake at the 122nd Henry George Commemorative Dinner, with Karl Fitzgerald

Renegade Economists radio show #430

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Karl Fitzgerald: And welcome the Renegade Economist with your host, Karl Fitzgerald. And, my, oh, my, hasn’t it been in the news, negative gearing, there’s been a huge change in sentiment not only from both political parties, but from the media itself. And who better to hear it from than Saul Eslake, yes,, one of the nation’s leading economists. Alright, let’s step into things.

When you hear about negative gearing today hopefully most of you know that this is the ability to write off losses on your property investment against your income. That gives property investors the ability to outbid everyday mum and dad homebuyers and it’s been going on for too long. And when you hear the term called “grandfathering” that means allowing what’s already happened to continue and just starting off from a certain date as in July 2017. Alright, let’s get into it.

We welcome to the show Saul Eslake, one of Australia’s foremost economists who many will know through his work at the Grattan Institute, the ANZ Bank and the nightly news. So Saul, welcome to the show. It’s just quite an extraordinary situation after for so many years working on negative gearing reform to see it now at the sort of policy focus level we’ve been waiting for.

Saul Eslake: Yes, in some ways, echoing Malcolm Turnbull, I’m tempered to say that there’s never been a more exciting time to be an advocate of changes to Australia’s long-standing negative gearing arrangements. I feel, and I suspect you do too, that you’ve been banging your heads against a brick wall of Treasurers for more than 20 years, remembering that Wayne Swan was no more willing to contemplate any changes to negative gearing than were Peter Costello or John Howard before him, or Tony Abbott or, until his last day in parliament, Joe Hockey after him.

Yet now we have a situation where the opposition has put forward some very significant changes to negative gearing arrangements, they’re not perfect in my view, but they would represent a significant improvement on what we currently have. And for its part the government seems to be sending off signals that it’s prepared to contemplate cracking down on what it has thus far mysteriously described as “excesses and abuses” in the negative gearing system, so even they might be prepared to do something as well. And all of a sudden it does seem as though at least some change is in the wind, no matter what happens to the outcome of the next election.

Karl: And certainly when you look at the headlines, there are pieces on The Australian Financial Review like end the negative gearing Ponzi scheme. Of course, The Daily Telegraph and some of those sort of newspapers are engaging in the sort of scaremongering we’d expect, that any change to negative gearing is going to increase rents. Now Saul, you’ve been very prominent in dispelling this negative gearing myth. Can you please spell out to us what happened, once and for all, in the mid-‘80s when Paul Keating did curtail negative gearing?

Saul: I sometimes say in my bolder moments that the arguments that are run regarding what allegedly happened when Paul Keating temporarily abolished negative gearing between 1985 and ’87 are a contemporary example of what Joseph Goebbels is alleged to have said when he was Hitler’s Propaganda Minister, that if a lie is big enough and you tell it often enough it becomes accepted as the truth.

So routinely has the assertion that during this period in the late 1980s rents went through the roof and the government was then forced to backtrack on its earlier policy decision, so often has that been trotted out. Some years ago I went back to look at the data to seek truth from facts, as Deng Xiaoping used to say, and what the data shows is that rents did indeed rise quite significantly in Sydney and Perth during this period between mid-’85 and mid-’87 when negative gearing for property investments was temporarily unavailable, but they didn’t rise significantly in any other Australian city.

Now, negative gearing was withdrawn nationally, so if there was to have been any impact as a direct result of that change it should have shown up in all cities since they were all affected by that policy change, but they only showed up in Perth and Sydney because in those two cities the vacancy rate was unusually low. In Sydney it was actually just below 2% and in Perth it was just above 2%, notwithstanding, I should say, the fact that negative gearing had been available for 50 years prior to that point. So if negative gearing was encourages increases in the supply of rental housing over that sort of period of time the vacancy rate probably shouldn’t have been as low as it actually was, given that immigration wasn’t running all that strongly at that time.

So the assertion that is so often made about what allegedly happened in the mid-1980s and what would, so the argument runs, happen again should any government have the temerity to interfere with this tax break just simply doesn’t send a moment’s confrontation with the facts.

Karl: And this urban myth was actually repeated by Treasury Secretary John Fraser, one of the highest ranking economists in the country, last week at a Senate Economics Committee.

Senator: Just last question to finish up this, is there any evidence from work that’s been done or that you’ve seen across the board as to whether negative gearing has an impact on availability of rents and a change in policy, how that would impact rents or rental yields? It’s always rolled out by the real estate industry in discussions on this topic, but I’m wondering where we go to to get that kind of analysis and data?

John Fraser: I’m testing my memory and I’m looking – Nigel’s too young, but when the negative gearing was wound back in the ‘80s?

Male: Yeah.

John Fraser: The reason why it had been brought in, one of the reasons had been to increase the supply of rental housing and I think, I think I was overseas at the time, I think the evidence was such –

Male: That it was brought back in.

John Fraser: Yeah, and so it was brought back in.

Senator: Sorry, so that’s why it was brought back in, to increase the? So my understanding was that maybe it was Sydney and Perth, there was some structural shortages at the time which led to some underlying –

Male: So I think there were some underlying – I think you’re, I think you’re correct Senator.

Karl: And so this myth is still being propagated by those who should know better. What can we do to really put these people on notice that that’s no longer acceptable?

Saul: I was surprised by John Fraser’s comments as well. I have a lot of respect for John Fraser. He interviewed me for my first job with the Federal Treasury in 1979 and he was, in my view, rightly regarded as one of Treasury’s most capable and intelligent mid-ranking officers, as he then was, and of course he’s had a stellar career in the private sector since leaving Treasury in the early 1990s.

So I’m genuinely surprised that someone of Mr Fraser’s knowledge and capacity would make so elementary a mistake as that without first checking the facts. After all, he would have been in Treasury during that period when that policy change was made. Indeed, he might have been involved in advising both on the original policy change and the subsequent backtracking of it, and hopefully he would have been advising against it. But it does just illustrate the potency of the property industry’s campaigning on this score and underscores my earlier observation that, echoing Goebbels, if you tell a lie often enough and it’s big enough many people will come to accept it as the truth, even though it’s far from being the truth.

Karl: Well let’s step into the detail of Bill Shorten’s proposed negative gearing reforms, and that is to limit negative gearing to new housing only and also, importantly, to halve the capital gains tax discount to 25%. Now that is to come into play in July 2017. Saul Eslake, what do you see are the strengths and weaknesses of this sort of reform?

Saul: Well, the idealist in me cavils that many of the compromises that are inherent in the Labor Party’s policy. I hate the idea of grandfathering, for example, because it amounts to privileging people on the basis of birth order. Those who were fortunate enough to get their snouts in this particular trough some time ago or who have them there by the 30th of June next year will, if the Labor Party comes to office, be able to keep them there, while those who haven’t been so quick or adept will miss out on the opportunity to reduce tax and defer tax that negative gearing grants its participants.

Having said that, I’m also conscious of the saying that you can’t get the perfect to be the enemy of the good and what Labor is proposing will curtail negative gearing over time. The average property investment is typically held for about eight years, it may well end up being held for a longer period as people seek to retain the privileges associated with negative gearing that they’ll be able to retain on assets which they already hold. And that incidentally, of course, argues against the proposition that’s sometimes put as part of the scaremongering campaign that this change will lead to wholesale dumping of investment properties by existing landlords, therefore supposedly putting dramatic upward pressure on rents.

The historical reality is that almost any major change to the tax system including, for example, the introduction of the capital gains tax back in May 1985 or September 1985 by Paul Keating is almost always accompanied by grandfathering of existing investments because no politician who aspires to be in government or remain in government can really afford to be open to the charge that they’re breaching faith with investors who’ve entered into long term transactions, as they often are, under the assumption that the existing laws would remain unchanged. So, as I say, I don’t like grandfathering much, but I can understand the reason for it and the reality is that if they weren’t prepared to grandfather it they probably wouldn’t be making any change at all.

Similarly, I’m not wholly persuaded by the logic of continuing to allow negative gearing for new housing because the risk is that, unless state and local governments alter their planning and building regulations and laws, then the supply side of the housing market will still be as constrained as it is today and any effect that’s continuing to allow negative gearing for the purchase of new dwellings has in stimulating demand from investors for that kind of dwelling could simply serve to inflate the price of new dwellings. If that doesn’t happen then I suppose the Labor Party argues that this exception will encourage an increase in the supply of new dwellings and that may be so, it remains to be seen. But, as I say, if these are the compromises with the ultimate ideal that the Labor Party has felt it necessary to make in order to get the policy up in the first place, then at least what they’re proposing represents a significant improvement over what we currently have. And for someone who’s been arguing against negative gearing for over 20 years to no effect until now, over the next 20 years probably negative gearing will gradually fade away even with the grandfathering provisions.

Turning to the reduction in the capital gains tax discount from the present 50% to a proposed 25%, that’s actually a much tougher policy than most people seem thus far to have realised. You might recall that the Henry Review recommended that the discount be wound back to 40%. That figure was as arbitrary as the 50% instituted by the Howard government in 1999, but 25% represents a much less generous concession to people who make capital gains than the present system or the one that Henry’s Review recommended. Arguably it is less generous, and the assumption that the inflation remains at the midpoint of the Reserve Bank’s 2% to 3% target, it’s less generous that the system which Paul Keating instituted when he brought in the capital gains tax in 1985 and which continued until Costello changed it in 1999, whereby capital gains tax was applied at full marginal rates to the gain after an allowance for inflation instead of the present arrangement where the capital gains tax is in effect applied at full marginal rate for half the nominal gap.

Karl: Well it seems like they’re having a bet both ways and I liked the statement in The Financial Review today in an article, you were quoted regarding capital gains tax and David Richardson, from Access Economics, said, “Look, negative gearing is the symptom, but the cause are the capital gains. So targeting that is a good idea”, as you certainly agreed in that article. So wouldn’t they be having a bet both ways by implementing both these policy twists at the same time?

Saul: Yes, in some ways they are. My thinking on this question has evolved over the last couple of years, partly because of the difficulty I’ve had, up until this point, getting any traction with the idea that negative gearing itself should be curtailed or abolished. My own work had showed, and I think it’s now widely accepted, that the change in the capital gains tax regime back in 1999 did more than anything else to enhance the popularity of negative gearing as an investment strategy. Because what it did in the minds of taxpayers and investors was to convert what had traditionally been a strategy that resulted in a deferral of tax into one which, with the 50% discount, became a strategy that allowed people not only to defer tax, but actually permanently to reduce it, depending on the size of the capital gain they made. So winding back the capital gains tax discounts would certainly reduce the appeal of negative gearing even if you continued to allow it under existing arrangements.

I’d argue that an additional desirable policy change, though not one which the government or the opposition has contemplated, would be to say not only should the discount be reduced from the present 50%, but that for people who do undertake negatively geared investments the excess interest over rental income which they seek to offset against their other wage and salary or other income ought to be subject to the same discount as well, whatever that discount figure actually is. So, for example, if it was still 50% then you would only be able to offset 50% of the excess interest you might have incurred under a negatively geared arrangement in any given one year against your other income for tax purposes rather than, as at present, all of it.

Karl: There are a lot of myths going around in the press at the moment, we’ve already dispelled one about negative gearing reforms in the mid-‘80s having led to rental increases. But another common one is saying that the majority of people who claim negative gearing deductions are low to medium income earners. How do they enact this sleight of hand, Saul Eslake?

Saul: Well, what they do is appeal to the statistics published at the end of April each year by the Australian Taxation Office called Taxation Statistics. You can find them on their website, it’s a fairly clunky set of Excel spreadsheets but, with a bit of effort, you can work your way around them.

What they do show at first instance is that almost 80% of the number of taxpayers who claim rental interest deductions have a taxable income of less than $80,000. And this then, combined with some of the data that the Tax Office also provides on the occupational status of different categories of taxpayers, helps underwrite the claim that negative gearing is mainly done by cops, teachers and nurses, among others, as if that somehow made it alright. I’d note in passing that police, teachers and nurses are much more likely to join trade unions, for example, than other members of the workforce but you don’t usually hear Coalition spokespeople saying that that’s a good thing as well and more people ought to do it. But the key point here is that these figures are based on taxable income and, of course, the whole purpose of negative gearing is to reduce your taxable income relative to your actual income.

The same set of figures can be used to show that the average rental interest deduction claimed by those taxpayers with a taxable income of less than $6,000 per year of those who make those claims is $11,500. That is almost twice their taxable income. Now my guess is there are not many bankers out there who would willingly lend to people whose total income is less than $6,000 a year. Indeed, the Taxation Office figures show, according to what the Labor Party has said though I haven’t verified this myself, that there are some 64,000 people making negative gearing claims who have no taxable income at all. In other words, what’s clearly evident is that the figures which are quoted by proponents of negative gearing to buttress this claim that negative gearing is actually something that ordinary mainstream Australians do en masse is quite misleading.

A far better guide to how negative gearing is used and by whom comes from the Stats Bureau’s regular surveys of income and wealth distribution. The most recent one of those for the 2013/14 financial year shows that 72% of the value of investment properties, that is all property other than owner-occupied housing, is owned by households in the top 20% of the wealth distribution, that is the richest fifth of Australian households, and that those same households own 52% of the amount of investment property-related debt. Figures from the University of Melbourne’s Household Income & Labour Dynamics Australia (HILDA) survey that have been put together by the Reserve Bank show much the same thing and the Reserve Bank has commented on this in some of its statements on monetary policy and reports on financial system stability.

The overwhelming majority of investment property debt is actually owed by rich folks, not by average ordinary mainstream Australians.

Karl: So over to the Liberal Party, they’re floating ideas that perhaps they’ll limit the number of properties someone could negatively gear. This seems to be a lesser reform but one that’s likely to appeal to their supporters and my initial feeling is that all of a sudden plenty of five and six year olds, plenty of kids will all of a sudden own real estate.

Saul: Well it’s hard to know exactly what the effects will be until we know what the Coalition government is proposing, if indeed it does anything at all. The suggestion I’ve heard is that they might put a cap on either the number or the value of properties owned by it could be an individual taxpayer or a household which would be eligible for negative gearing. Alternatively there could be a cap on the total amount that can be claimed by way of interest in excess of income by any individual taxpayer or a household through negative gearing.

Either way, it would appear that that would actually have its greatest impact on the wealthiest of households rather than on the somewhat larger number though smaller value of claims made by the cops, teachers and nurses among others of whom the Property Council and others are all of a sudden all so fond. In that case, you might be able to say that what the Coalition is proposing is actually more equitable in the sense that it has a bigger impact on higher income and richer households than what the Labor Party is proposing. You might then ask why would they do that and the answer might be because the people who’d be most affected by it would be most likely to live in very safe Liberal seats where their votes don’t count, whereas the so-called cops, teachers and nurses are of course much more evenly spread over marginal electorates where their votes do count.

Forgive the cynical interpretation of the government’s possible motives there, but I’ve learnt over the years that such cynicism doesn’t really do you any harm in seeking to interpret why politicians do what they do.

Karl: Saul Eslake, let’s finish with the possible timing of such a policy reform as we see markets in Perth and Darwin, certainly Melbourne and Sydney, being less healthy in the property sector. As rental yields continue at record lows, do you think at this point in the economic cycle, will it futureproof negative gearing reform by implementing it now?

Saul: I wouldn’t say this was the ideal time to have them implementing it. It might have been much better, including for those who’ve been squeezed out of the housing market over the last four or five years, if this had been done some time ago, as a few of us were advocating. So I think assertions that the sort of changes that are being proposed will lead to a tidal wave of selling of investment properties are about as believable as most of the other claims that are made by negative gearing’s proponents.

I mean, in the first instance the Labor Party’s proposal is to grandfather those who already have negatively geared investments and you would think, as I said before, that the result of that grandfathering would be to make it even less likely that people who own existing assets would sell them than any alternative policy. And I find it hard to believe that if the Coalition also seeks to do something in relation to negative gearing that it too wouldn’t grandfather existing investments, as the Labor Party is doing. But suppose, notwithstanding that argument, that there was to be some selling of negatively geared properties in the aftermath of such a change you have to ask yourself who would those properties be sold to?

Well they wouldn’t be sold to other investors presumably since they would likely be deterred by the inability to enter into tax-preferred negatively geared arrangements as the result of any change. Rather those properties would be sold, in all likelihood, to people who had been wanting to buy a home to live in themselves, but had been frustrated in their aspirations to do so by the competition they faced from investors who had their mortgage costs subsidised through the tax system by other taxpayers. So those homebuyers who therefore became successful in meeting their aspirations to buy their own home would cease to rent, the demand for rental housing would drop by the same amount as the supply of it allegedly would, and there should therefore be no net change in the balance between the supply or the demand for rental housing such as would have a material impact on rents.

It’s another one of the assertions made by defenders of negative gearing that, as I say, doesn’t survive a moment’s confrontation with facts.

Karl: Well Saul Eslake, any last piece of advice you can share with our listeners on what they can be doing right now to help push this momentum for negative gearing and capital gains tax reform?

Saul: I think the best advice I can give is to challenge the arguments that are put by defenders of negative gearing whenever you hear them. I mean, I’m not personally critical of the property industry for defending their own interests. That’s what interest groups are meant to do, that’s why people pay to join them is so that someone is out there arguing their case. You can’t, as Neville Wran used to say, blame self-interest, you can be sure that it’s always trying. What we can object to is people who equate self-interest with the national interest and politicians who fail to see self-interest masquerading as the national interest for what it is.

So my appeal would be to those who understand the arguments and want to see changes made in this area to stand up and call out these kind of arguments, hopefully using thoughts of their own or things that they’ve heard in our discussion today bolster their case so that ultimately right will prevail.

Karl: Saul Eslake, thanks so much for joining us here on the Renegade Economist.

Saul: It’s a real pleasure Karl, thank you for having me.

Karl: So there we have Saul Eslake., check out his work. Also, plug his name into our website and you’ll find his 122nd Annual Henry George Commemorative Dinner speech where he nailed all of those facts with charts, spells it out. You can read it in a bit more detail there. And please, pick up some of those key points and hit your MP with it. It’s just ballistic that the top 10% of income earners own 72% of housing wealth. That is a massive one. The top 20% are taking 80% of the capital gains write offs. The list goes on and on, it’s got to stop, it’s got to end, you know it’s been one of our primary issues here on 3CR’s Renegade Economist.

Now come and have a chat with us on Monday night in Hawthorn at the Lido Cinema, we’re watching The Big Short. Yes, The Big Short, all about the sort of financial shenanigans that have gone on in Wall Street. A lot of hype about the film so our team will be there and we’d love to meet with you at seven o’clock, details will be on the Prosper website soon. And check out for all of today’s show notes and I’ll provide more details there. Alrighty, thanks very much for listening. My name’s Karl Fitzgerald and watch out for The Boldness coming up very soon here on 3CR.