Reform tax distortions to tackle housing affordability

Tyler Trennery

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housingpic3Negative gearing and Capital Gains Tax concessions are driving speculation and decreasing housing affordability. It’s time for a serious rethink, writes Tyler Trennery.

There exists a reasonably broad consensus within Australian society that housing affordability is a serious issue and one which State and Federal governments need to address. Housing has placed an increasingly large burden on the disposable income of Australians despite the existence of historically low interest rates. This is no accident, and can be tied back to a series of policy decisions and distortions made over the last 30 years which have fundamentally changed the way government and society at large view housing.

Anyone who has followed submissions by organisations such as ACOSS and the Australia Institute on the issue of Australian housing will have come across denunciations of ‘negative gearing’ or the ‘capital gains discount’ but may not be aware of the details of these policies. I’ll attempt to briefly summarise the role they play and the distortions they’ve introduced into the Australian housing market before moving onto some less commonly discussed issues, which I argue should form part of a progressive reform of housing policy.

Negative gearing allows property investors to claim losses on the interest of their investment loans in housing against their personal income tax. If, for instance, someone in the top tax bracket loses $100 a week in interest on an investment property, they will be able to set this loss against their personal income. This means an annual loss of $5200 will be defrayed by a tax saving of around $2444.

When negative gearing existed in isolation it was a fairly ineffective policy. There was little evidence that it was being used to create more housing stock, but it was nothing like the $4.5 billion a year tax dodge it has become today. This change is directly related to the introduction in 1999 of a 50% discount on Capital Gains for individuals and trusts. In short, this allows an investor who purchases a property and sells it after more than a year to only pay tax on half of the Capital Profit.

If, for instance, an investor in the top tax bracket purchased a rental property in 2000 and sold it in 2010 and made a profit of $200,000 they would have paid $90,000 in Capital Gains Tax before this change. After this change they would only pay $45,000.

Any analyst of the Australian housing market will tell you this combination of tax distortions has encouraged highly speculative investment behaviour in residential housing, with the losses being defrayed by negative gearing allowing a taxpayer to be even more certain that the Capital Gain at the end of the process will more than make up for any losses in the meantime. Unsurprisingly, the losses claimed under negative gearing have exploded since 1999, increasing more than 12 times in less than two decades. At the same time, the concessional rate on Capital Gains Tax is costing taxpayers more than $5 billion per year despite the Howard Government arguing it would actually generate revenue.

Some argue that these tax distortions improve housing affordability by increasing investment in residential housing stock. Yet since 1999 the amount of disposable income that Australians are putting towards their housing repayments has increased from around 6% to more than 9.5%. This is unsurprising. Housing is a very passive investment, and the explosion of investment has overwhelmingly concentrated on existing housing stock, accounting for 95% of negatively geared properties. This has forced owner-occupiers to compete with speculative investors buoyed by the availability of very cheap debt and the generous tax concessions outlined above.

For many on the Left in Australia none of this is really news; these issues have been in the public debate for some time. Where I argue broader action must be taken is in relation to the tax treatment of land and the family home. At present the family home is entirely exempted from Capital Gains Tax and land is typically taxed indirectly through stamp duties, with tax being paid based on the price paid to purchase a particular property. A move to shift away from this model, which privileges profits made from residential housing over other savings vehicles, would help to take some of the heat out of the domestic housing market whilst simultaneously driving a rethink in the way Australians consider housing, away from a profit making vehicle to fund their retirement and towards a more utilitarian perspective that’s more fitting of such a fundamental social good.

At present the exemption on the family home costs the federal budget approximately $50 billion per year. Whether a family house is sold for $500,000 or $10,000,000, a taxpayer will not pay a single cent of capital gains tax. It’s not at all clear what social or policy outcome this concession is intended to achieve. Some argue that as the family home is the primary savings vehicle for Australian families it should receive favoured tax treatment, yet other savings vehicles such as the interest from the bank, or contributions to a superannuation account are still taxed (albeit at an outrageous discount in the latter case).

The privileged treatment of housing profits certainly does nothing to increase the amount of domestic housing stock. On the contrary it creates every incentive for home owners to hold out for the highest price possible. Insofar as there’s an argument that the generous treatment of savings in the form of the family home is necessary to fund an Australian’s retirement and aged care needs the 10s of billions of dollars in revenue that are lost to the government might well be able to achieve this goal more effectively and equitably if they were directed towards the public provision of these services, rather than the generous treatment of housing profits.

Simultaneously, stamp duty as it’s currently levied by State governments does nothing but increase the price of domestic housing. If there were any single policy step which would immediately impact housing affordability, it would be the elimination of stamp duty. This could be made even more effective by replacing it with a broad based federal land tax. Not only would this generate substantial revenue in a far more efficient way, it would also incentivise more varied residential housing options such as apartments and smaller homes as they are far more land efficient.

Another upside is that it would encourage the more efficient use of housing. Many of us will be familiar with families whose children have moved out who are nonetheless living in a property with more bedrooms than currently needed. If such a property were taxed in a way that consistently took the land use into account these property owners would be incentivised to either downsize, or offer out part of the property for rent. In either case the existing waste of housing stock that the current tax structure supports would be significantly ameliorated.

The changes I’ve outlined above would be politically controversial. They run directly counter to very significant vested financial and cultural interests, but the very significant revenue they would unlock would allow for a range of popular progressive policy steps. Perhaps if a federal land tax could be structured in a way that it was able to replace all existing local government levies as well as stamp duty, a range of services such as aged care or the pension could be extended and strengthened with the billions in revenue generated by reform.

Most polling suggests that throughout recent decades Australians have been lukewarm about both major parties, and are desperate to see the services they value and require properly funded and supported. Bold policies on tax reform would allow a progressive Labor government put together the sort of expansive reform agenda that could appeal to these widespread sentiments whilst simultaneously changing the domestic housing market in a way that shifts its emphasis away from profiteering, and towards the efficient and affordable provision of housing.