DAVID KOCH: Abolish negative gearing at your peril but rorting must end

Abolish negative gearing at your peril — but there is no doubt it needs reform because the system is being rorted.

Negative gearing was introduced in Australia in 1936, in the midst of the Great Depression, to encourage investors to buy property and then rent it out to those who couldn’t afford to buy their own home.

The intention was to ease the financial burden of the large upfront and ongoing costs of buying a rental property when compared to other more traditional investments.

Negative gearing tax concessions were designed to subsidise those early losses until the property became profitable for the investor.

Since then, negative gearing has become a national obsession as the best way to build assets and reduce your tax.

Instead of being used to soften the financial blow of early losses until it became profitable, investment properties are now continually refinanced so they remain permanently unprofitable, and the tax concessions are claimed ad infinitum.

Overlay that with the 50 per cent capital gains tax discount when an investment property is sold, and you can understand what a great deal it is for investors.

According to the Australian Tax Office, there are 2.2 million landlords and 1.2 million have a negatively geared property. Those negative gearing tax deductions are worth $5.7 billion, plus another $5.22 billion from the capital gains tax concessions.

That’s almost $11 billion in tax concessions a year to property investors which is ultimately funded by every other taxpayer. That’s a lot of tax revenue handed out and why governments have constantly considered abolishing it.

The reason they don’t is that they’d probably lose 1.2 million votes from disgruntled investors, which could include 20 of the 23 Labor Cabinet ministers who own an investment property and 18 of the 23 shadow ministers.

It is a myth that property investors are moguls. They’re more likely to be a next door neighbour or friend.

Just over 71 per cent own just one investment property and 19 per cent own two.

They’re ordinary Australians trying to build a nest egg.

And while 12 per cent of these property investors are aged 65-74 years old, the others are spread pretty evenly across all age other groups.

Back in the mid-80s, then-treasurer Paul Keating fiddled around with negative gearing by limiting the tax break for interest costs to the rental income on property.

The result was investors left the property market in droves, rental properties dried up, vacancies plunged and rents skyrocketed.

The treasurer soon reversed his changes as low income earners found it increasingly difficult to pay their rent or even find appropriate rental accommodation.

So be careful what you wish for.

Having said that, there is no doubt the system is being rorted and has moved away from the original intention for which negative gearing was introduced.

I know this tax break is enormously popular because it has helped so many people buy an investment property, and many of those have made a lot of money as Australia’s housing market has boomed.

Abolishing negative gearing completely would cause massive disruption in the property market (as Keating found) but subsidising loss-making properties just cannot go on forever.

The solution is to revert to the original intention of the policy back in the 1930s.

Five years should give property investors enough time for the property to increase in value, for rents to rise and move into positive gearing where rents cover the mortgage.

From that point, the tax concessions should be scaled back or stopped completely. An investment property can’t be constantly refinanced to maintain the negative gearing tax concessions.

An upper limit could also be imposed to limit the number of properties which can be negatively geared by any one taxpayer.

Sure, negative gearing helps create a greater supply of residential property for rent, but it also distorts the property market, pushing up prices more than they would without government intervention and creating an uneven playing field to the point that it makes more financial sense to buy an investment property than it does to buy a home to live in.

More importantly — and dangerously — it legitimises investing in a loss-making asset, purely for tax purposes, even where there is little hope that the property will ever turn a profit.

In other words, it encourages banks to lend, and buyers to invest, in assets that make a regular loss from the moment they are purchased. That just can’t make sense in the long run.

And the bigger the shortfall, the bigger the tax break.

So, if you buy a house and the mortgage interest is $1000 a month, but your rental income is only $500, the government will refund you part of the monthly loss up to the level of your marginal tax rate.

So, if you pay tax at 30 per cent, you get $150 back from the government each month. But pay tax at 45 per cent, and you get back $225.

Negative gearing is terrific in encouraging investors to provide much-needed rental property but it has become a tax rort for some and limits need to be applied to take the whole policy back to its original intention.

David Koch is the economic director of Compare the Market