Negative GEARing – Greasing the Engine of the Australian Property Market

Posted by Daniel Joseph

The debate surrounding negative gearing is an enduring one, often dominated by hyperbole that borders on fear mongering. More recently, the debate has turned to the possibility of abolishing (at least to some degree) the tax incentive.

In a nutshell, negative gearing occurs when you borrow to invest in an income producing asset and the cost of borrowing exceeds the returns (income) from that asset. The amount by which costs exceed income can be used as a deduction on your taxable income.

Sounds simple enough, right, so why all the debate?

In 1985 the Hawke/Keating government quarantined negative gearing interest expenses (on new transactions), so interest could only be claimed against rental income, not other income. Any excess could be carried forward and used in subsequent years. What followed was a significant increase in rents to a peak in June 1987. The argument is that the existing rules were an effective rental subsidy that pushed rental growth down below the rate of inflation (negative gearing incentivised investor activity increases the supply of residential accommodation, subsequently dampening rental growth). Research has consistently shown that there is a heavy concentration of investor-owned dwellings in the inner- and middle-ring suburbs of our largest capital cities ; remove a portion of the rental stock in these locations and some increases in rents would be certain.

Here are a few reasons why negative gearing is likely to remain intact:

Negative gearing is helping create the supply that’s needed, estimated at more than 180,000 dwellings per annum.
Between 1985 and 1987 the numbers on the New South Wales housing waiting list increased by almost a third from fewer than 110,000 up to nearly 140,000 in only eighteen months, a trend that was reversed with the re-introduction of the previous ruling on interest deductions.
A review on access to public housing in Victoria found that in 2011 operating costs exceeded rental revenue by 42 per cent, up from 30 per cent in 2002. The main source of social housing is public but a growing proportion is privately funded. Removing negative gearing will reduce the amount of housing in the social housing pool.
In 1985 investor finance accounted for a miserly 13 per cent of total housing finance, compared to a whopping 40 per cent or $139 billion of domestic investor finance over the past twelve months alone. Clearly the effects of a policy change in the current climate will have more far reaching implications than did the 1985 policy reversal.

Posted by Daniel Joseph, on 5th May 2015