OPINION: NEGATIVE gearing applies if the annual cash costs from investing in a leveraged property exceed the annual cash revenue generated.
The current base case, under Australian tax law, allows the resulting cash loss to be deducted from the investor’s income from other sources, reducing their overall taxable income and final tax bill.
This Report “Economic Impact of Limiting the Tax Deductibility of Negatively Geared Residential Investment Properties” measures the effect of limiting negative gearing, an alternative case that assumes:
- Abolition for established dwellings – removal of tax deductibility of losses on established residential property against general income
- New properties exempt – the change applies to established dwellings only; new dwellings continue to attract concession as per usual
- Grandfathering – the new policy applies to purchases of property made on or after 1 July 2016, but purchases of property made before 1 July 2016 would not be affected
- Deductibility within property portfolio – no restriction on negative gearing deductions against another property owned by the same taxpayer
- No change to related taxes – capital gains tax and stamp duty remain unchanged
- No change to other asset classes – negative gearing offset remains for shares, etc
In effect, the current negative gearing tax provision would be replaced by ‘neutral gearing’, for established properties.
We find that limiting tax deductibility of negatively geared residential investment properties would have consequences that go well beyond any tax saving to the Federal budget:
- Rents will rise by up to 10% ($2,600) per annum
- New home building will shrink by around 4% nationally, or 7,200 dwellings a year
- GDP would shrink by around $19 billion per annum on average, equating to some 1% of Australia’s $190 billion annual income
- 175,000 fewer jobs would be created over the next 10 years, resulting in the unemployment rate rising from 5.8% to 5.9%
- Government revenue across a range of taxes would shrink by $1.65 billion per annum
- 70,000 extra households would be pushed into housing rental stress
- If the government were to compensate these stressed households, it would require an additional subsidy outlay of $650 million per annum.
In other words, the impact would go well beyond any saving of the income tax concession, to a multitude of unintended consequences.
Why would limiting negative gearing have this adverse impact?
The policy intervention would raise rents. Developers will find that the expected return from developing new dwellings is now lower, relative to cost, diminishing their ability to build new homes. Lower rental stock means higher rents. Over time, rents are projected to be between 1.7% and 10% higher across the capital cities by 2026.
The housing shortage will grow. The policy change will create a ‘discouraged investor effect’ that will dampen investor demand for housing. Although pre-existing investments would continue to receive the original tax benefit, current investors will now have a strong incentive to hang on to their grandfathered investment property, in order to prolong the legacy of the old regime. And while negative gearing would still apply to new dwellings, it is doubtful that this would attract significant investment funds into new dwellings: when you later came to sell a property acquired after 1st of July 2016, the next owner won’t qualify for negative gearing – and therefore you would not be able to sell it without taking a price fall.
This will lead to weaker new home building of around 4% nationally, or 7200 dwellings a year, resulting in a greater cumulative housing stock deficiency by the end of the forecast horizon. The impact would be concentrated in Sydney and Melbourne, and to a lesser degree Brisbane and Perth. Apartment building would bear the brunt, more so than detached houses.
Lower new dwelling building numbers will mean real GDP is forecast to shrink by a cumulative $190 billion over the 10 years. The largest decline in output by industry sector is expected in dwelling building, which would be lower by $57 billion over the next ten years.
In turn, sectors which service or supply inputs to the residential building industry will be slower, with a flow on to the rest of the economy. We estimate that around 175,000 fewer jobs will be created in the economy under the alternative scenario, and the unemployment rate will rise from 5.8% to 5.9%.
More households would be pushed into housing stress. Rental dwellings are especially important to those on lower incomes, and the young. An additional 70,000 households would be pushed into rental stress. If the government were to compensate them, we estimate that the subsidy will range from $4 to $24 per week per household in each state, and amount to a total subsidy of $650 million per annum.
Government tax revenues would shrink. The Federal government will save $2.1 billion per annum as fewer individuals deduct losses from property, but will incur an income tax loss from lower home building of $1.8 billion. Stamp duty revenue will fall by around $1.1 billion per annum; GST collections will drop by $0.2 billion a year.
Altogether, total tax revenue is likely to fall by $1.65 billion per year.
At the end of a 10-year horizon the market would find a new normal, but the legacy will be a ‘lost decade’. Rents will sit 2-10% higher depending on the city.
The dwelling stock deficiency will be 60,000 homes (instead of 20,000). GDP growth and tax revenue will track lower. And more people will have been pushed over the threshold into housing unaffordability, resulting in a welfare loss predominantly borne by those in lower income brackets.
By Kim Hawtrey, associate director head of building at BIS Shrapnel.
Australian Property Journal
