Negative Gearing – Harmful to our economy?

Negative Gearing – Harmful to our economy?

Given the current taxation policies, negative gearing has become one of the most popular forms of investments in Australia. Under the policy, the government has spent over $10B in taxpayer’s money in the form of tax cuts and benefits. A question thus remains: is negative gearing doing harm to our economy as we know it? This article aims to address this question. Firstly, however, let’s explore what negative gearing is.

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What is negative gearing?

Negative gearing is a mode of financial investment where the investor acquires an income-producing asset such that the cost of owning the asset outweighs the income it generates.

 

Seemingly counterintuitive, the attractiveness of negative gearing, lies in the fact that the benefits if realised, far exceed the short-term losses. The benefits are tax concessions and capital gains.

 

Taxation Discount and Capital Gains – Explained

Current tax policies dictate that any net loss experienced by a negatively geared asset could be offset against the investor’s other taxable income. This results in lowered overall tax expenses.

 

To illustrate the power of such a policy, let’s look at an example.

 

Imagine that Tom earns a salary of $80,000 a year. One day, he decides to buy an investment property worth $400,000 so he borrows $400,000 with a 6% investment interest rate ($24,000 a year). The property’s yearly expense is $5000 and the rental income is $500 a week (or $26,000 a year).

 

Without Investment PropertyNegatively Geared Investment Property
Salary$80,000$80,000
Plus Rental Income$26,000
Less Interest($24,000)
Less property expenses($5,000)
Taxable income$80,000$77,000
Tax + medicare levy($19,147)($18,112)
NET INCOME$60,853$58,888

 

As the above table demonstrates, Tom actually ends up paying $1035 less tax when he holds the investment property through negative gearing. Whilst his net income does decrease by $1.965, he now holds a $400,000 property that could grow significantly in value over time in a strong market.

 

Impact of negative gearing on the property market

The current tax policies surrounding negative gearing is arguably quite unhealthy for both the Australian property market and the economy. They incentivise high-end investors to purchase more property, pushing up house prices and reducing affordability for the average earner. What is worse is that a 2015 report by the Australian Council for Social Services found that over 90% of loans go towards existing investment homes, which means that not only is homeownership reduced, but there is nothing done to increase supply.

 

So what would things look like if these tax policies were abolished? A quantitative study recently presented to the Reserve Bank of Australia found some staggering economic implications. It found that not only would house prices soften by 1.2% but up to 75% of households would be able to own their homes. Furthermore, there would be an overall welfare gain of 1.5% GDP.

 

Negative Gearing Policies – Need for Reform?

In light of the above, there has in fact been a stronger push to abolish the current tax policies. Recently the Labour Government proposed a new policy overhaul that aims to ‘level the playing field.’ Under this policy, Investors will no longer be allowed to use net investment losses to offset against income. Furthermore, the capital gains discount tax will be lowered to 25%.

 

The catch, however, is that these tough reforms will only apply to investors purchasing existing properties. Investors who construct new homes and increase supply could still enjoy the tax benefits.

 

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Ranin Mendis

CEO & Co-founder of LoanDolphin