To negative gear or not to negative gear that is the question

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Every year Australians enjoy around $36 billion worth of tax breaks on their family home while at the same time enjoying tax breaks on superannuation payouts, combined with negative gearing.

Australians also have capital gains tax exemption on a person's principal place of residence and the ability to negatively gear, irrespective of how wealthy a taxpayer is.

There is now about 1.2 million Australians who negatively gear, which means they deduct any losses they make on ­investments, including mortgage interest, from their overall income when they calculate their tax liability.

Tax Office statistics show negatively geared property investors claimed $13.2 billion in losses in 2010-11, up from $10.1 billion the year before. The average loss per negatively geared investor was $10,950, but this loss doubled for those earning more than $180,000 to $23,800.

An option to limit the number of investors accessing negative gearing, by restricting the tax benefit to new housing, could ­substantially reduce that figure, and have an added benefit of increasing housing supply, some groups say?

Australia is one of only a few developed nations that allows negative gearing, which economist Saul Eslake says is wasted money that inflates house prices.

This is made worse, he says, by a raft of other policies including the Howard government's 1999 decision to tax capital gains at half the rate applicable to other income and the decision by successive federal and state governments to boost first home buyer grants.

Mr Eslake, who was part of the former­ ­government's National Housing Supply Council which was in charge of devising ways to improve housing affordability and meet Australia's future housing needs, has long been an advocate of scrapping negative gearing.

Speaking in a personal capacity, he said first home buyer grants and negative gearing boost demand and reduce affordability.

"One of the arguments from the defenders of negative gearing is that it increases the supply of rental housing by attracting investment into the property market" said Mr Eslake, now chief economist of Bank of America Merrill Lynch.

"That's a very poor argument because over 90% is used to buy existing dwellings. Moreover, most countries that don't have negative gearing, have higher vacancy rates."

Treasurer Joe Hockey has previously said the Coalition's tax white paper will examine negative gearing.

Restricting negative gearing to new properties would be a similar move to what governments in Victoria and NSW did by limiting the first home owners grant to newly built homes and apartments.

The restriction of grant to new homes has seen a temporary boost in new home building in those states, although the long-term impacts are yet to show.

As Mr Eslake says, it's highly unlikely the Abbott government will make a ­"politically courageous decision" to touch ­negative gearing.

It's been a politically vexed topic since 1985 when Paul Keating tightened it. He had wanted to scrap it altogether. But Labour was forced to re-introduce it in 1987, after house prices in ­certain capital cities fell and the property industry mounted political pressure to ­reinstate the tax break to its original form.

It was a valuable lesson on the sacred nature of the family home. A recent report by the ­Grattan Institute said home owners receive tax breaks on the family home worth $36 billion a year, or $6,100 per household, because of the exclusion of the family home from capital gains tax, land tax and the pension asset test.

Other research by Grattan found that ­making owner-occupied housing liable for capital gains tax could generate tax revenue of $15 billion (collections could be anywhere between zero and $36 billion depending on if the capital gains tax discount of 50% remained, whether owners could keep ­claiming tax deductions for the interest paid on mortgages, and future rises in house prices).

The ­Grattan Institute chief executive John Daley said scrapping or restricting negative gearing would increase rates of home ownership by reducing demand for investment properties.

He said if negative gearing was restricted to new housing, a key issue would be the transition. "It would create incentives to hold ­anything you already own, potentially locking up housing in an unproductive way, given that the average investment property is at present only held for three to four years," he said.

A better option might be to reduce the ­percentage of losses that can be claimed. For example, 20% each year for five years, would "lead to a more orderly transition".

In Eslake's view the government should abolish negative gearing entirely, rather than restrict it to new homes. "If you restrict to only to people who buy new dwellings that might tweak it in favour of new dwellings and that would be a desirable outcome," he said. "The only problem is that negative gearing is available at the moment for all investments – if you borrow money to buy shares, gold, taxi licence plates, you're entitled to use it . . . I think the answer instead is deny it to everyone."

The 2010 Henry Review said negative ­gearing was one of a plethora of inefficient taxes, including stamp duty, and called for it to be abolished. But it said any changes to ­negative gearing or the capital gains tax "may in the short term reduce residential property investment" and that "in a market facing ­supply constraints, these reforms could place further pressure on the availability of ­affordable rental accommodation within the private rental market".

The review suggested such reforms ­therefore "should only be adopted following reforms to the supply of housing and reforms to housing assistance".

Housing Industry Australia chief economist Harley Dale warned tinkering with the system would have a "massive negative impact on investor sentiment". He said rental supply wouldn't increase if investors were not ­confident. If the government really wanted to increase housing supply it should look to the Henry Review recommendations which ­suggest other changes such as cuts to ­inefficient state taxes like stamp duty, ahead of negative gearing, Mr Dale said.

The inevitable consequence of any type of tax reform is "someone is going to be worse off," Mr Daley said. He admits that taking away negative gearing will impact on middle-income earners, and will reduce house prices.

But in his view, any decision that makes housing more affordable for the bottom 20% of income earners would be a good policy move, even if some voters don't agree.

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