Australia’s housing crisis: Removing negative gearing will make it worse

Just days after Treasurer Jim Chalmers again ruled out changes to negative gearing and the capital gains tax discount in his upcoming budget, the two tax breaks for property investors are back in the news. 

This time cross-bench senators David Pocock and Jacqui Lambie are leading the charge.

The two senators, whose votes are often crucial to getting government legislation through parliament, say changes need to be made to the two schemes.

They claim this would create the conditions for more Australians to be able to afford to buy homes and save the Federal budget up to $60 billion over a decade. 

To back their claim, the pair commissioned the Parliamentary Budget Office to examine five options for reform.

The background

Currently, negative gearing comes into effect when the costs of owning a rental property (including mortgage interest) are greater than the rental income it generates.

So if you find yourself “negatively geared” (making a loss on your investment, not a profit), you can deduct that loss against your total taxable income, therefore paying less tax.

People who sell an asset (like an investment property) at a profit need to pay capital gains tax (CGT). 

However, Australian residents who have held an asset for at least a year are currently entitled to a 50% discount on the CGT they will be asked to pay.

There’s no question that rental property deductions cost the federal budget a lot.

The Federal Treasury recently revealed that rental property deductions would jump by an estimated 58% from $17.1 billion to $27.1 billion by 2023-24, largely because of much higher interest rates on investment property mortgages this financial year. 

Political parties like The Greens argue these tax breaks are unfair and push up the cost of housing for all, while social service groups like ACOSS argue Australia’s tax system “encourages people to borrow more than they would otherwise in order to speculate on property values.”

So what does the research say?

The Parliamentary Budget Office (PBO)—which conducts independent economic modelling and research for Federal MPs—looked at different options, mixing and matching various changes to the negative gearing and Capital Gains Tax regimes.

The most substantial reform proposal is estimated to save the Federal budget $60 billion over ten years by 1st July 2034.

That would see negative gearing abolished, and the CGT discount limited to properties bought before the 1st of July this year.

A more modest change, which would see a 25% CGT discount stay only for newly built homes and negative gearing limited to only one investment property, would raise $16 billion over the next decade. 

Independent Senator David Pocock says the Parliamentary Budget Office report puts forward "sensible" options to help turn the housing crisis around.

"Home ownership is declining.” 

“Rental affordability has never been worse.” 

“We need to make sensible changes," he says.

So would it be “sensible” to remove negative gearing? 

In a nutshell, no.

Negative gearing has been allowed in Australia in one form or another since 1936—except for two years in the mid-1980s when it was removed and then reinstated two years later by then Treasurer Paul Keating.

Why was it reinstated so quickly?

“There was a shortage of housing, and rents rose during the two years it was abolished,” says Associate Professor Michelle Cull from the School of Business at the University of Western Sydney.

She says negative gearing was originally introduced because “it was thought it would encourage investment in housing and increase supply.”

And to be frank, that’s still largely the case. 

Ray White’s Chief Economist, Nerida Conisbee, recently studied the contribution of private landlords to housing in Australia.

What she found is, frankly, stunning.

“Between 1996 and 2021, there were an additional 1.1 million rental properties provided by investors (private landlords),” Ms. Conisbee says.

“Compare this to an increase of 41,000 homes provided by community groups and a LOSS of 53,000 rental properties provided by the government.”

You read that correctly.

Despite all the trumpeting of state governments about “Big Builds” and “massive” housing investment, there is actually less publicly-owned housing today than there was when You Am I’s “Hi-Fi Way” topped the charts. 

You see, despite hoovering up all those property taxes, state governments have actually been really reluctant to invest big sums in public housing. 

Why?

It costs a lot to plan, design, and build really high-quality public housing stock, and then it’s incredibly expensive to maintain it. 

Until recently, public housing hasn’t been seen as a political priority for state and territory governments, who instead seem fixated on big infrastructure projects, blowouts in hospital budgets and crime. 

They’ve been happy to increasingly leave the “heavy lifting” to the private market and let the Commonwealth bear the cost via foregone income tax revenue.

“Although they are frequently criticised, incentives available to property investors in Australia have been successful in providing a steady stream of rental properties and keeping the proportion of households under rental stress at globally low levels,” Ray White’s Nerida Conisbee says.

“If tax policy is changed that makes owning a rental property less attractive, there will immediately be far fewer rental properties available.” 

That’s clearly demonstrated in this chart from the Parliamentary Budget Office advice provided to Senators Pocock and Lambie.

Introducing any policy that would change the playing field for private landlords (who, after all, provide the overwhelming bulk of Australia’s rental housing) would cause massive upheavals, with tens of thousands of property investors likely to exit the market nationally.

In the last year alone, we’ve had clear examples of the impact of policies seen as penalising landlords.

Concerns over Queensland and Victoria’s tax regimes for property investors saw hundreds of investors sell up, particularly in Brisbane and Melbourne, leading to a dire shortage of rental properties and driving up rents in both cities way above inflation; 10.7% and 14% respectively, over the past year, according to Domain.  

The Parliamentary Budget Office research suggested that changes to negative gearing and the CGT might encourage property investors to look at other assets, such as shares, meaning there would be less competition for potential first-home buyers.

However, the research did point out that would also mean fewer available rental properties.

I’m all for giving first-home buyers a leg up, but this ignores the fact that one-third of Australian households are renters, and not everyone aspires to home ownership. 

Many international students, temporary visa holders and new migrants are either not allowed to become homeowners or are not in the financial position to do so.

A growing number of younger Australians also choose to “rentvest”—buy a property they can afford and rent where they want to live—usually close to work, their family, and their friends.  

But let’s give the last word to respected economist Peter Tulip, who’s worked for both the Reserve Bank of Australia and the US Federal Reserve. 

“There are repeated claims that negative gearing makes housing expensive,” he says.

“These claims are refuted by well-known research.”

In fact, he says, “several studies using different approaches estimate that the effect (of removing negative gearing on Australian house prices) would be trivial”.

Of these studies, Peter Tulip says the most detailed study is by Cho, Li, and Uren (2021), who find that removing negative gearing would increase home ownership by 4.3% but reduce house prices by only 1.5%. 

However, it would also raise rents by 3.6% and, in an extremely alarming finding, the Federal government would have to increase the welfare budget by 1.7% to offset costs like higher rents. 

It would be a politically brave government that trades away an incentive that’s encouraged investors into property for nearly 90 years for that unimpressive result.