Incentive-driven negative gearing fails test of effective policy

Not unexpectedly, last week Housing Industry Association managing director Shane Goodwin mounted a public defence of negative gearing against claims that it exacerbated housing affordability problems. 

Focusing on excessive and inefficient taxes on new housing and red tape generally, Mr Goodwin welcomed "increased investor activity as good news for housing activity, market confidence and keeping the lid on rents". 

If the real intention underlying the open-ended budgetary support of negative gearing is to improve housing affordability including by increasing the housing stock, it's a costly and inefficient way of doing so. 

The negative gearing tax deductions are available on virtually unlimited terms for all investments yielding assessable income, no matter how large the borrowing. Moreover, as far as housing investments are concerned, a large part of the taxation benefits accrue to purchasers of existing properties, including many in the high price range. 

Unlike the superannuation regulations that require trustees to behave as prudent investors and avoid engaging in related party transactions, the negative gearing benefits are open to conflicted related party transactions and not subject to close scrutiny. For example, if the government's intention is to increase the supply of lower cost affordable rental housing, the unlimited taxation benefits could be restricted to such investments. It would then be feasible for the government to follow other countries in limiting the taxation assistance for loss-making investments. 

The United States, for instance, limits the annual deduction for investment expenses to the gross income earned, allowing any losses above these amounts to be carried forward as future tax deductions. This is essentially how our capital gains tax loss provisions operate. 

In effect, the accumulated carry-forward losses would be utilised when the investment becomes profitable and would increase the incentives to do so. 

The Australian negative gearing provisions provide no tax incentive for investors to move their investment into profitability and, in essence, encourage investors to maximise their losses. As a consequence, a very tax-effective strategy is to focus all savings on paying off a non-tax-deductible home mortgage while retaining an interest-only highly geared investment mortgage. 

Apart from its open-ended tax benefits, negative gearing has been encouraged by the major reduction in the generosity of the superannuation tax concessions. The maximum taxation benefits of super contributions for taxpayers earning more than $300,000 annually is now only 16.5 per cent in the dollar and the maximum tax benefit is only $4590 a year. 

The tax benefit of negative gearing for these same taxpayers is 46.5 per cent in the dollar and there is no limit on the amount claimed. With this pattern of incentives operating, it is no surprise that negative gearing has regained the popularity lost because of the global financial crisis.

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Daryl Dixon

Executive Chairman

Daryl Dixon is one of Australia’s foremost investment experts and a well known writer and consultant. He has provided trusted advice to thousands of personal clients over more than 25 years and is an acknowledged expert in the areas of tax, superannuation (including public sector superannuation), social security and investments.

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