Joe Hockey recently declared the end of the Age of Entitlement. It was a welcome announcement; at the very top of his list of entitlements to review should be negative gearing, a tax break first designed to ensure the supply of new housing to the market, but now effectively inflating the price of homes out of the reach of ordinary first home buyers.
In 2010-2011, the ATO recorded that landlords in Australia claimed net losses of $13.3 billion on their investment properties. It's hard to determine exactly how much of this figure could have been federal revenue, but a recent report by the Grattan Institute estimates that the government misses out on $2.4 billion annually by allowing investors to write off their losses against other income.
Economist Saul Eslake believes the amount of revenue foregone as a result of negatively gearing is closer to $5 billion each year. Such a generous tax concession might be understandable if it produced a social or economic good, but it's difficult to see the wider benefits of negative gearing.
Unfortunately, any public debate about the policy tends divide along tribal lines. Renters blame homeowners for housing inequity, while homeowners deride the lack of fiscal responsibility among renters. This divide obscures the actual policy impacts of negative gearing, hindering any real discussion about the costs and benefits of providing this tax break.
At its core, negative gearing dictates that the federal government must guarantee private property investment by foregoing a few billion in revenue each year. Supporters of negative gearing, such as the Real Estate Institute of Australia, argue that the policy helps to keep rental prices down by promoting the supply of new housing to the market.
This argument ignores the fact that roughly 90 per cent of investors choose to invest in existing dwellings. This is sensible behaviour in you're investing in property, as there are great risks involved in buying houses "off-the-plan".
Yet, because investors are reluctant to fund new housing developments, the primary policy outcome of negative gearing is the increase in demand for existing dwellings. This has resulted in significant increases in housing prices in Australia, which remain well above the OECD average for both buying and renting.
Although it's difficult to predict the direction of housing prices, commentators have begun to suggest that the housing market in Australia may be on the brink of collapse. Last year the Reserve Bank asked property investors to "maintain realistic expectations of future dwelling price growth", which suggests that we may be seeing the end of rising property prices.
More dramatically, US economist Harry S Dent Jr. has warned of an impending property crash in Australia, stating that housing prices in Melbourne and Sydney by at least 27 per cent over the next few years. While this might be welcome news for renters wanting to buy a home, a collapse in housing prices would be disastrous for investors, some of whom have leveraged their superannuation funds to buy investment properties.
Although it's hard to say where the where the market will go, it's clear that the market conditions propagated by negative gearing have created a precarious situation in the housing market.
Asking Australian taxpayers to subsidise housing investment seems unfair in the context of the wider economy. As is the case with every tax concession, those who do not benefit from it must shoulder a greater tax burden to make up for revenue loss. If the federal government is willing to continue providing such significant tax breaks, they should be targeted at sectors that can provide a greater ongoing benefit to the nation.
While abrupt, the new government's refusal to hand over subsidies to manufacturers and primary producers could be understandable if their opposition to entitlements was consistent. However, as pointed out by many commentators in the last week, there are plenty of industries which the government still continues to subsidise in a less conspicuous manner.
By allowing continuation of negative gearing to continue, Canberra is spending billions each year to prevent the normal operation of market forces. This is clearly not good public policy. At the very least, the government needs to cap the losses of negatively geared investments by adopting the reforms proposed in the Henry Tax Review, or announce plans to quarantine negatively geared tax write-offs to real estate investments, similar to the system in the United Kingdom.
As the government confronts a shrinking tax base it will be required to make changes to the taxation system as well as looking for savings. To achieve this, Canberra should be looking for ways to boost productivity by first putting an end to entitlements that promote poor policy outcomes.
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