Commonwealth taxation settings
A major focus of this inquiry was the relationship between Commonwealth
taxation settings and housing affordability.
Investors in real estate, like investors in other asset classes, are
able to deduct losses from their investment, including interest paid on
borrowings, against other assessable personal income. This arrangement is
commonly known as 'negative gearing'. Again, like investors in other asset
classes, property investors are also generally able to claim a
50 per cent discount on any realised capital gain on an investment
property, so long as that property has been held for more than 12 months.
This chapter examines the various arguments made by witnesses regarding
the effect on housing affordability of negative gearing arrangements and the
capital gains tax (CGT) discount, or indeed the two taken together. Broadly
speaking, critics of negative gearing and the CGT discount told the committee
that current settings distorted demand and had an inflationary impact on
purchase affordability. In contrast, other witnesses contended that the
existing tax treatment of investor housing was consistent with the tax treatment
of other asset classes, and moreover served to stimulate housing supply and
contain rental prices. After canvassing these different arguments, this chapter
outlines options for reform that might be investigated be the government.
Although not attracting as much attention as the tax treatment of the
investor housing, some submitters focused on the exemption of owner-occupied
housing from CGT. The CGT exemption, these witnesses argued, encouraged
Australians to 'overinvest' in their housing, placing further upward pressure
on prices, thus favouring existing home owners at the expense of would-be first
home buyers. This chapter considers these arguments.
The tax treatment of investor housing
negative gearing and the CGT discount
In Australian tax law, investors have a right to offset non-capital
losses from an income producing asset against their personal income, and can
thereby reduce the overall amount of personal income tax payable. 'Negative
gearing' is commonly taken to refer to the ability of landlords to deduct
losses from mortgage-financed rental property, including interest paid on
borrowings to acquire the property, from their overall assessable income
(including labour income).
It is important to note, however, that other assets, such as shares, are
subject to the same tax treatment. The ability to negatively gear a residential
investment property is not, in other words, a housing-specific exception to or
departure from the broader Australian tax law, even if it is often perceived as
Of course, even for income earners in the higher marginal tax brackets,
discounted losses are still losses. However, property investors generally
pursue a negative gearing strategy in the expectation that a property's capital
appreciation will more than make up for the losses they incur from holding the
property. While capital gains are subject to taxation (except for gains on
assets acquired prior to the introduction of CGT in September 1985), this tax
is only payable when a capital gain is realised—for instance, when an asset,
such as an investment property, is sold. And whereas capital gains are taxed at
the same rate as a taxpayer's other income, a CGT discount, which reduces the
taxable gain by 50 per cent, applies for an asset held for more than
12 months. In this sense, an investor may pursue a negative gearing
strategy with a view to not only deferring their tax liability, but indeed
permanently reducing it by, in effect, converting income gains into discounted
Prior to 1999, capital gains were adjusted for inflation then taxed at
the taxpayer's full marginal rate. Since 1999, CGT has been levied on nominal
capital gains, with individuals and trusts (but not companies) eligible for the
aforementioned 50 per cent discount.
The changes to the CGT reforms, according to the 1999 Review of Business
Taxation ('the Ralph Report') in which they were proposed, were intended to
'increase the international competitiveness of Australian business and to
encourage greater investment by Australians'.
According to Mr Eslake, whatever the original intent the combined effect
of the 1999 CGT changes and already extant negative gearing arrangements has
been to create a vehicle for permanently reducing, rather than simply
deferring, personal income tax liability.
Other witnesses also drew the committee's attention to the asymmetric
treatment of expenses and capital gains for housing investors, and the
incentive this creates to invest in housing as a means of minimising tax
liability. As ACOSS explained:
While deductions for investment expenses are a
well-established and legitimate feature of the income tax system, deductions
for 'negatively geared' investments in assets that yield capital gains
(including property, shares and collectables) are not properly matched (in
timing or in value) with the related income stream. Taxpayers receive immediate
deductions at their current marginal tax rate against future income that mainly
takes the form of capital gains.
Mr Eslake suggested that the increase in landlords claiming losses
since 1999 underlined the growth in popularity of negative gearing as a tax
strategy since the abovementioned changes to the CGT regime:
In 1998–99, when capital gains were last taxed at the same
rate as other types of income (less an allowance for inflation), Australia had
1.3 million tax-paying landlords who in total made a taxable profit of almost
$700 [million]. By 2010–11, the latest year for which statistics are
presently available, the number of tax-paying landlords had risen to over 1.8
[million] (or 14% of the total number of individual taxpayers), but they
collectively lost more than $7.8 [billion], largely because the amount
they paid out in interest rose more than fourfold (from just over
$5 [billion] to almost $23 [billion] over this period), while the
amount they collected in rent 'only' slightly less than trebled (from $11 [billion]
to $30 [billion]), as did other (non-interest) expenses.
The Henry Review observed that around 70 per cent of property
investors in 2006–07 were negatively geared, up from 58 per cent in
AHURI also highlighted the popularity of negative gearing. In its submission,
it pointed to figures from the ATO showing two-thirds of individuals deriving
rent had a net rental loss from their property.
Other AHURI sponsored research, however, has suggested that this figure
may be significantly overstated for a range of reasons, and estimated that the
proportion of residential landlords claiming rental losses might only be
The Australia Institute, while concerned at the prevalence of negative gearing,
conceded that in a low interest environment the proportion of landlords
claiming overall losses had declined.
Review and the tax treatment of investment housing
It is worth noting at this juncture that the Henry Review included
recommendations directed toward providing for a more consistent tax treatment
of gains and losses from savings. The review found that the inconsistent
treatment of household savings led to significant arbitrage opportunities:
The different treatment of capital gains as against other
savings income and related expenses is an important driver of these
opportunities. This creates significant distortions in how rental properties,
in particular, are financed and for the rental property market.
To this end, the review recommended applying a 40 per cent
discount to most interest income, net residential rental property income,
capital gains and certain interest expenses (recommendation 14). In
addition to allowing for a 40 per cent discount on (among other
things) rental income, this would also mean that only 40 per cent of
interest (and other expenses) could be claimed as deductions, and the current
50 per cent capital gains discount would be reduced to a 40
per cent discount. The Henry Review explained how these changes were
expected to impact investment in housing:
The current personal income tax system favourably treats
capital gains and amplifies this benefit when investments are geared. By
discounting net rental income at the same rate as capital gains, the tax
treatment of investor housing will be less responsive to gearing levels and
capital gains, creating a more neutral treatment of different forms of saving...
The proposed reforms would reduce the bias in favour of the
capital gains generated in rental properties by treating it more neutrally
compared to rental yield. Over the long term, this is likely to change investor
demand toward housing with higher rental yields and longer investment horizons.
This may also result in a more stable housing market, as the current incentive
for investors to chase large capital gains in housing would be reduced.
As Professor Yates pointed out, the tax treatment of investor housing
was recognised in the Henry Review as 'amongst the greatest tax-induced biases
to the savings choices of households'.
However, the Henry Review acknowledged that its recommended reforms could have
an adverse short-term impact on the level of investment in housing in Australia.
As such, it recommended that the reforms as they related to investor housing
should only be implemented after the delivery of separate reforms relating to
the supply of housing and the provision of housing assistance.
Regardless, on release of the report the then government announced that
it would not implement certain recommendations in the report 'at any stage',
including recommendation 14. The government further announced that it would not
consider reducing the CGT discount or applying a discount to negative gearing
gearing and purchase affordability
Using the 2010–11 losses declared, Mr Eslake estimated a cost to revenue
from negative gearing of $5 billion; this was, he contended, a 'pretty
large subsidy from people who are working and saving to people who are
borrowing and speculating'. More than that, he continued:
...it's hard to think of any worthwhile public policy purpose
which is served by it. It certainly does nothing to increase the supply of
housing, since the vast majority of landlords buy established properties: 92%
of all borrowing by residential property investors over the past decade has
been for the purchase of established dwellings, as against about 72% of all
borrowing by owner-occupiers.
Precisely for that reason, the availability of 'negative
gearing' contributes to upward pressure on the prices of established dwellings,
and thus diminishes housing affordability for would-be home buyers.
Making a similar point, ACOSS submitted that not only did the benefits
of negative gearing skew heavily toward higher income earners, but that it
served to inflate housing costs and fuel 'speculative booms in the housing
market'. This, ACOSS suggested, was a function of the fact that 90 per
cent of investment in negatively geared housing stock applies to existing
Referring to the tax treatment of investor housing (and owner-occupied
housing, as discussed later in this chapter), the CFRC also argued that tax
settings such as negative gearing lowered the cost of housing for investors.
This in turn reinforced:
...factors that add to housing demand and compound dwelling
price pressures in the presence of supply inelasticities. Given their typically
pro-cyclical effect they enhance rather than counteract market volatility and
can lead to lower rates of growth.
Referring to the interaction between negative gearing and CGT
arrangements, the Executive Officer of National Shelter, Mr Adrian
Pisarski, told the committee that these tax arrangements served to inflate
demand in a system with inadequate supply. In this sense, the current taxation
treatment of investor housing reinforced the barriers to market entry for
We have a well-documented undersupply of housing overall and
an even larger documented undersupply of affordable housing. Lots of people
want to get into home ownership in Australia but cannot afford to, and they are
being out-competed by people who have a pocketful of tax incentives. You cannot
create a properly effective, equal, free market if you distort it in such ways.
We have these massive distortions that really advantage investors over people
who want to purchase to occupy a property.
Likewise, the Australia Institute argued that the taxation treatment of
investor housing favoured property investors at the direct expense of people
looking to purchase their first home:
High income households are particularly favoured as they have
the financial capacity to purchase property and a larger taxable income to
deduct losses from. Through providing such generous tax benefits government
policy has increased the demand for investment housing. First home owners, who
often have less financial capacity, must now compete against investors for
properties. These tax concessions are inequitable and further reinforce the intergenerational
and income gap between home owners and first home buyers or renters.
Other witnesses, including NT Shelter, Uniting Communities, Tenants
Union of Victoria and Youth Action NSW also argued that the current taxation
treatment of investor housing created speculative demand, forcing prices higher
and making it more difficult for first home buyers to buy a home at a price
they could afford.
In contrast, the REIA told the committee that it was a strong proponent
of negative gearing because it adds to housing supply. Given negative gearing
stimulated housing supply, the REIA argued, it was questionable whether it did,
in fact, add to the cost of housing.
The HIA made a similar argument, writing that negative gearing was being blamed
for distortions in the housing market that were in fact caused by supply
Under current policy settings as they apply to Australia's
housing industry, there are a number of distortions to the housing market which
are causing an undersupply of housing and placing an undue upward pressure on
rents. Negative gearing does not fall into this category.
Independent economic modelling commissioned by HIA finds that
reducing negative gearing concessions in the current housing policy environment
would exacerbate existing distortions and reduce housing affordability.
Treasury was asked by the committee to comment on a just-released
Moody's report suggesting the existence of negative gearing adds about
9 per cent, or $44,000, to the cost of an average home in markets
with high incomes. Mr Rob Heferen, Executive Director of Treasury's Revenue
Group, indicated that he was not yet familiar with the report. Nonetheless, Mr
Heferen explained why such findings needed to be treated with a degree of
[O]ften when these exercises are done they are done in an
'all other things being equal' kind of scenario. You limit interest deductions
on investor properties to rental income. The negative gearing that comes from
those interest deductions can be used to offset against other income. So, if
you limit it to rental income, what is the change in the return that the
investor gets and then taking that away? Often what those sorts of exercises do
not do—and it is no surprise they do not do it, because it is extraordinarily
complex—is to work out, if that money goes away, where it will then be invested
and what is then the effect on the macro-economy. So that feedback loop that
goes into more of a general equilibrium kind of thinking is something that is
extraordinarily difficult. Often when it is small amounts of money it is
largely irrelevant, but I suspect that, once it gets up into several billions
of dollars, that is the kind of time when those secondary effects or the
feedback effects become more important. That kind of modelling capacity is very
unusual. It is quite rare. Certainly we in the Treasury attempt to get and
maintain some expertise in that, but it also becomes very assumption driven. If
the return is not there for an investor, where would they put that dollar?
gearing and rental affordability
In 1985, the Australian Government enacted legislation that
'quarantined' losses made from owning rental properties, so that losses from
rental properties could only be deducted from rental income. In contrast to the
arrangements which prevail today, during the quarantine period these losses
could not be used to reduce tax on other sources of assessable income. Losses
could, however, be carried forward to offset future rental profits and capital
gains from the sale of such investments. The changes only applied to real
estate purchased after 17 July 1985.
In 1987, the decision to quarantine negative gearing was reversed
(with effect from 1 July 1987). The decision was ostensibly made for two
reasons. First, ending the quarantine would result in uniformity of tax
treatment of interest costs for all types of investment. Second, the government
concluded the tax benefit to high income earners offered by negative gearing
was adequately countered by other tax reform measures introduced subsequent to
the enactment of the quarantine, notably the introduction of the CGT regime in
However, some students of the decision have suggested it was, in the main, a
response to political pressure. This pressure, they argue, came from a housing
industry that argued (rightly or wrongly) that the quarantine had driven up
rents as landlords were forced to pass the cost of the higher tax burden on to
The committee heard a variety of views regarding the impact of negative
gearing on rents, and various interpretations of the effects of the quarantine.
As noted above, the REIA argued that negative gearing added to housing supply,
including the supply of rental accommodation. It contended that changing
negative gearing rules, including along the lines suggested by the Henry
Review, would place added pressure on supply in an already tight market.
Implementing the Henry Review recommendations, the REIA calculated, would add
2 per cent to the rental cost of a median three bedroom house. The
REIA also highlighted the 1980s quarantine as proof of the risks associated
with any move to limit the application of negative gearing for investment
property. According to the REIA, in the two years the quarantine was in place,
rents increased by 57.5 per cent in Sydney, 38.2 per cent
in Perth and 32 per cent in Brisbane.
In contrast, AHURI suggested that on the whole the recommendations of
the Henry Review would improve rental affordability. This, it suggested, was
because while the after-tax economic costs for negatively geared investors
would increase, the costs for equity investors would decline. These lower costs
would flow through:
...into long term average annual rents, which would fall by
just over $300 per year (Wood 2011). This would have a mixed effect
on investors' willingness to retain investments: unleveraged and equity
oriented investors would likely be more inclined to retain investments under
the reforms while negatively geared investors would be more likely to realise their
investments. Because these supply responses would offset each other, a 'flight
of investors' from private rental housing seems unlikely.
Mr Eslake also disputed the idea that the abolition of negative gearing
would force up rents. The alleged 'landlords strike' of the mid-1980s, he
argued, was based on an erroneous reading of history: rents had only risen
rapidly in two markets, Sydney and Perth, because both cities had unusually low
rental vacancy rates at the time. Yet in other capital cities, where vacancy
rates were higher, growth in rents were either unchanged or, in the case of
Melbourne, actually slowed. Mr Eslake continued that notwithstanding this
history, if a large number of landlords were to sell their properties in
response to the abolition of 'negative gearing', this would not necessarily be
a bad thing for renters:
That would push down the prices of investment properties,
making them more affordable to would-be home buyers, allowing more of them to
become home-owners, and thereby reducing the demand for rental properties in
almost exactly the same proportion as the reduction in the supply of them. It's
actually quite difficult to think of anything that would do more to improve
affordability conditions for would-be homebuyers than the abolition of
There's no evidence to support the assertion made by
proponents of the continued existence of 'negative gearing' that it results in
more rental housing being available than would be the case were it to be
In broad terms, Mr John Hawkins put forth a similar argument,
challenging the notion that the abolition of existing negative gearing
arrangements would result in a 'calamitous reduction in the supply of rental
It has been claimed that after the restoration of negative
gearing [in 1987] there was an increase in residential housing investment. But
correlation does not prove causation. The stock market collapsed in late 1987
and it was this more than the restoration of negative gearing that made
property investment appear more attractive.
The common claim that, were concessional capital gains tax
and negative gearing to be removed, investors would push up rents to ensure
they receive an adequate return does not stack up. What is more likely is that
the price of houses would fall until the rate of return on them is back to an
adequate return (ie comparable in risk-adjusted terms to that on other
Mr Pisarski of National Shelter, also felt that it was necessary to
directly address what he regarded as misconceptions about the effects of the
[The quarantine] happened to coincide with an increase in the
share market at the time, and therefore capital moved from the sector of
housing into the sector of shares, and negative-gearing changes that [Treasurer
Paul] Keating introduced were blamed for that shift. It would have happened
anyway. It was not to do with any negative-gearing changes, but a whole
mythology has grown up that therefore negative gearing is a sacred cow and if
you touch that we will suddenly have a collapse of the rental market. That is
just not so. And if we did have people selling off lots of properties in the
rental market because they no longer saw it as a good investment, then who
would they sell them to? Presumably it would be to people who wanted to occupy
them and live in them. Would that be a bad thing?
Some witnesses not only took issue with the contention that negative
gearing helped contain rents, but also contended that negative gearing actually
served to distort the rental market in such a way as to undermine rental
affordability. For example, the Tenants' Union of NSW suggested that negative
gearing fuelled the speculative pursuit of capital gains by property investors,
and made investors relatively indifferent to rental yield. The Tenants' Union
of NSW further argued that this had on negative effect on the availability of affordable
In particular, the amount of low-cost rental stock has
declined, both relatively and, at the lowest end of the market, absolutely.
This is because landlords in pursuit of speculative gains
tend to purchase existing stock with high prospects of capital gain, and high
values – and hence high rents. When low-prospect, low-value, low-rent stock
comes up for sale, speculator landlords tend to pass over it, and it drops out
of the rental market—and such stock as remains becomes scarcer, and less cheap
Professor Beer made much the same point, telling the committee that one
of the most damaging perverse outcomes of the current negative gearing regime
was that it encouraged investors to seek capital gains over yield. In pursuit
of capital gains, investors overinvested in high-end property, and
underinvested in low-end rental property 'where there is the greatest need'.
The flip-side of the same dynamic was that investors tended to underinvest in
smaller or depressed markets where the capital gains appeared less reliable.
Other witnesses argued that because negative gearing privileges capital
gains over yield, it had the unintended consequence of discouraging
institutional investment in the housing system. This is because unlike
individual (or 'mum and dad') investors, institutional investors require
steady, reliable yields to justify debt financing. For instance, ACOSS
submitted that the current tax treatment of investor housing:
...skews investment in housing towards individual investors
(rather than institutions) and towards investments yielding capital gains
(rather than a stable rental income stream).
Similarly, Mr Cameron Murray also suggested that negative
...incentivises private rental housing provision by wage
earners with high marginal tax rates, to the exclusion of institutional
investors who successfully provide large shares of rental housing stock in much
of Central Europe.
Other submitters, including the Equality Rights Alliance and Youth
Action NSW, also disputed the claim that negative gearing arrangements helped
to contain rental prices.
Some witnesses, such as United Communities and Tenants Union of Victoria,
suggested that negative gearing and the CGT discount actually worked to push
rental prices higher, with the increased cost of home ownership flowing through
to increased competition (and thus prices) for rental accommodation.
Rather than underpinning the steady and affordable provision of rental
accommodation supply, AHURI pointed to research suggesting negative gearing
added to volatility in the rental market:
Modelling by AHURI suggests that one-in-four property
investments are withdrawn from the rental market within 12 months (Wood 2010).
Thus tenants of approximately one quarter of all rental properties occupy
insecure accommodation. Low-income, and negatively geared property investors,
are more likely to make early exits from the rental housing market: in one
year, 50 per cent of negatively geared investors in the study sample sold the
property, by comparison with 20 per cent of all investors (Wood 2010).
Negatively geared investors also appear to move in and out of property
investments, in a 5 year period 13 per cent had repeat spells in home ownership
When asked by the committee about the relationship between negative
gearing and rental affordability, Treasury was somewhat equivocal in its
response: Mr Heferen told the committee that while he assumed the removal
of negative gearing would lead to rental increases, it remained a matter of
conjecture as to whether this is what had happened in the mid-1980s.
negative gearing serve housing policy?
According to the Association of Superannuation Funds of Australia
(ASFA), the policy rationale of negative gearing is to encourage investment in
those assets it applies to:
With respect to residential property, a deduction is only available
to the extent that the property is made available for rent, reflecting the
policy rationale to increase the stock of available rental property.
The question of how well negative gearing serves this purpose, and
whether the taxation treatment of investor housing should be designed to
support housing supply and affordability more broadly, was a key focus of many
critics of negative gearing during this inquiry. For instance, Anglicare
Australia argued that while the tax settings for investor housing may have once
played a role in encouraging investment in the housing market, these settings:
...no longer serve a purpose for the common good but rather
serve to benefit a select group. The negative gearing and capital gains tax
mechanisms need to be put back on the table, have their utility assessed and
then reformed as necessary to support the supply of new housing or affordable
housing to those most in need.
Mr Pisarski of National Shelter also told the committee that while
he did not necessarily think negative gearing or CGT discounts should be
abolished altogether, 'if we are going to provide these tax incentives we ought
to get a public good out the other side'.
ACOSS also approached the issue of negative gearing by suggesting the
Commonwealth was 'spending' $8 billion every year on investor housing tax
concessions, with half of that amount 'going to expenditure on negative
gearing'. Ms Jacqueline Phillips, ACOSS Director of Policy, told the
I think it is really important that we as a community ask
ourselves what we are getting for that money. We are not getting any new
affordable housing stock. We know that 92 per cent of investment in negatively
geared properties is in existing stock. We are not getting affordable rental
Drawing out the link of its characterisation of negative gearing as a
tax expenditure on housing, ACOSS suggested that savings from the
grandfathering of negative gearing (a recommendation discussed below) should be
directed in part toward investment in affordable housing programs.
AHURI, meanwhile, noted research indicating that the beneficiaries of
tax expenditures on investor housing (and, as discussed later in this chapter,
owner-occupied housing) were disproportionally high income earners and people
over 45 years old.
The RDC, however, noted that ATO statistics suggested that
72.3 per cent of all loss-making properties in 2010–11 were owned by
individuals on an annual income below $80,000. Indeed, the RDC argued that
negative gearing had 'created a positive relationship of mutual dependence
between low and middle income Australians'. According to the RDC, the majority
of negative gearing benefits flowed to middle-income Australia, which in turn
provided a 'steady supply of essential, affordable housing for low income
Characterising negative gearing as it applies to residential investment
property as a 'tax expenditure' is problematic. The government's Tax
Expenditures Statement 2014 explains that tax expenditures arise:
...where the actual tax treatment of an activity or class of
taxpayer differs from the benchmark tax treatment.
Tax expenditures typically involve tax exemptions, deductions
or offsets, concessional tax rates and deferrals of tax liability.
What is and is not considered a 'tax expenditure' by the government
depends on how the benchmark is specified. According to the Treasury, a
'benchmark should represent the standard tax treatment that applies to similar
taxpayers or types of activity'. However, it may also 'incorporate certain
elements of the tax system which depart from a uniform treatment of taxpayers
where these are fundamental structural elements of the tax system'. As could be
inferred from this explanation, determining the benchmark is not always clear
cut and does involve, in Treasury's words, 'an element of judgement'.
The ability to deduct expenses incurred in earning income is considered
a structural feature of the tax system. In this sense, negative gearing on
investment property—and indeed other assets—is not regarded as a departure from
the benchmark taxation treatment. As such, negative gearing is not included in
the annual Tax Expenditures Statement released by the government.
(However, the 50 per cent discount on CGT for assets held longer than
12 months, including investment properties, is regarded as a tax
Because Treasury treats losses on negatively geared property as regular
deductions, rather than tax expenditures, it was unable to quantify the cost to
It might also be noted that even if Treasury's non-recognition of negative
gearing as a tax expenditure were set aside, the use of 'revenue forgone'
methods of estimating the value of investor housing-related negative gearing
may not properly represent the cost to the Budget. This is because taxpayers
would almost certainly adjust their behaviour if negative gearing on investor
housing were not allowed. As the Tax Expenditures Statement explains,
'Introducing a tax expenditure may create incentives for taxpayers to change
their behaviour to utilise (or avoid) the new tax provision. Removing the tax
expenditure (so that the benchmark tax treatment prevailed) would remove this
incentive and may cause a corresponding change in taxpayer behaviour.' Such
behavioural changes could mean taxpayers seek to make use of other tax
expenditures, meaning actual revenue gain might be considerably lower than
simple 'revenue forgone' estimates would suggest.
Putting aside the definitional issues, and the exact cost to revenue of
investor housing-related negative gearing, several witnesses took issue with
the idea that negative gearing constituted a 'loophole' or departure from the
broader taxation system. These submitters argued that any change to the ability
of property investors to claim losses on an investment property against income
(whether earned against that property or otherwise) would amount to a
distortionary departure from Australia's established taxation framework. For
instance, the REIA argued that amendments to negative gearing provisions for
housing would amount to:
...treating real estate differently to other asset classes and
create a distortion on the investment landscape and result in a resource
Dr Harley Dale, the Chief Economist of the HIA, made a similar point,
arguing that the HIA's modelling of the impact of removing or restricting
negative gearing provisions as they applied to investor housing was based on
the fact that negative gearing applies to many asset classes, not just
residential property. As such, the HIA believed that removing or restricting
negative gearing provisions as they applied to housing would have two damaging
The first is that you would get a decline in Australian
living standards, because you would be placing an additional tax distortion on
what is already the second most highly taxed sector of the Australian economy.
Second, you would be providing a disincentive to invest, so you would see a
decline in rental property and an increase in rental prices.
The HIA was keen to draw attention to what it regarded as the popular
misconception that negative gearing is a housing-specific tax arrangement:
The ability to offset investment expenses against income in
establishing gross taxable earnings is a key tenet of the Australian tax
system. Beyond the sphere of residential property the appropriateness of this
fundamental feature of Australia's tax system is rarely questioned. However, it
is a highly contentious issue with respect to residential property,
particularly with regard to a focus on possible influences it has on the
purchasing behaviour of investors and owner occupiers.
Similarly, Mr Rob Johnson contended that it was incorrect to argue that
negative gearing had undermined the equity and integrity of the income tax
system, or that the tax laws gave specific preference to property investment.
There were, he argued, 'no loopholes, no rorts, no special provisions—there are
simply no advantages given to investment in property under the tax laws'.
Although some submitters suggested that the policy rationale of
existing negative gearing arrangements as they applied to housing was to
stimulate housing supply (as distinct from suggesting that these arrangements should
be designed to do so), Treasury explained that this was not strictly correct.
Rather, negative gearing as it applied to housing investment was no different
to how it applied to other asset classes; in this sense, Treasury explained, it
would be misleading to suggest that the 'policy justification' of negative
gearing was to increase housing supply:
In one sense there is no policy justification for negative
gearing. From a tax point of view we have two sorts of income, if you like: we
have 'income' income and then we have capital gains. So capital losses can be
only quarantined to use against capital gains.
But on income that is not capital gains income, basically all
costs are deductable against all income. So it is not as if there is an
explicit decision to say, 'Yes, there will be a decision to allow people to
deduct interest costs from, say, salary and wage income or other business
income.' That does not really occur. It is a question of what is allowed. Then
the policy intervention is: 'Okay; that is what the law allows; should the law
be changed to deny people the capacity to claim that deduction?'
gearing: recommendations for change
Some witnesses advocated limiting the application of negative gearing
provisions with a view to stimulating the supply of new housing stock. For
instance, the Australia Institute told the committee that despite its
aforementioned concerns about the impact of negative gearing on housing
affordability, it was:
...not proposing that we take out negative gearing. Negative
gearing is a policy that works for families, in the way that companies are able
to write off tax against profit losses as well. There is an advantage for
people as well. But the opportunity exists for the negative-gearing policy to
be a tool in addressing the issue of housing affordability. Targeting the
application of negative gearing rather than saying, across the board, 'Any
property is open to negative gearing,' would be one way of maximising the
benefit of the resources that the government provides through the concessions
of negative gearing.
Baptist Care Australia made a similar recommendation, suggesting that
negative gearing might be limited so that it only applied to the construction
of new homes or for investment in social housing (including Defence Housing).
Meanwhile, Mr Borrowman, Associate Professor Frost and Dr Kazakevitch, in a
joint submission, recommended that negative gearing be restricted to new
housing stock for a limited period of time, 'to provide incentives for
investment in new housing, which may be riskier than other forms of housing
The Victorian Public Tenants Association and the Equality Rights Alliance also
provided submissions recommending that negative gearing only be allowed for new
housing (with both suggesting that current arrangements might be
AHL Investments Pty Ltd (the 'Aussie' financial group) recommended the
introduction of limits on the number of properties that could be negative
geared or a ceiling on the amount of losses deductible in any given year. This
approach, it argued, would 'limit exploitative use of these concessions (such
as individuals claiming deductions on high-value or multiple properties),
rather than target those diversifying savings for retirement'.
For its part, ACOSS recommended that deductions of expenses for all
'passive investments'—by which it meant 'housing, shares, collectibles and
similar assets'—should be 'quarantined to offset income received from those
assets, including capital gains realised on their subsequent sale'. ACOSS
recommended that the current taxation arrangements be grandfathered for
existing investments, so that the effect on housing investment would be
This change, ACOSS suggested, would constitute a 'first step to improving
housing market outcomes and reducing the fiscal and social cost of this tax
break'. Further, ACOSS recommended that half the revenue saved from this change
should be 'earmarked for the introduction of an Affordable Housing Growth Fund
and [the] proposed expansion of NRAS to promote fresh investment in affordable
Mr Eslake stressed that his preference was not that negative gearing
only be abolished for property investors, but that it be abolished for all
investors. Thus, interest expenses:
...would only be deductible in any given year up to the amount
of investment income earned in that year, with any excess 'carried forward'
against the ultimate capital gains tax liability, rather than used to reduce
the tax payable on wage and salary or other income (as is the case in the
United States and most other 'advanced' economies).
Mr Eslake continued that, as a second-best option, the government should
implement the recommendations of the Henry Review bearing on the taxation of
investments (as outlined earlier in this chapter). Mr Eslake noted that
implementing these recommendations:
...would not amount to the abolition of 'negative gearing'; it
would just make it less generous than it is at the moment. It would be likely,
as the Henry Review suggested, 'to change investor demand toward housing with
higher rental yields and longer investment horizons [and] may result in a more
stable housing market, as the current incentive for investors to chase large
capital gains in housing would be reduced'.
Existing arrangements, Mr Eslake 'grudgingly' accepted, might need
to be grandfathered so as not to directly disadvantage current housing
The Tenant's Union of NSW floated a range of possible approaches to
reforming negative gearing and CGT arrangements for investor housing. These
included requiring that losses incurred from owning an asset could only be set
against income from that asset class. Drawing on the recommendations of the
Henry Review, the Tenants' Union of NSW suggested an alternative approach might
be to make income from a (non-business) asset subject to a tax discount,
'reducing (but not eliminating) the deductibility of losses against other
sources of income and the preferential treatment of speculative gains'. Yet
another approach, it suggested, might be to only allow negative gearing
arrangements for new housing stock. The common thread uniting these
recommendations was the need, according to the Tenants' Union of NSW, to
restrain speculation in the housing market:
This means resetting the tax settings that give preferential
treatment to owner-occupied housing, and that encourage people to lever up and
speculate as landlords.
Taxation of investment housing
capital gains: recommendations for change
Focusing specifically on the 50 per cent discount on CGT,
Professor Wilkins suggested the pre-1999 system of adjusting CGT payable for
inflation was preferable to the current discount on CGT liabilities. The
previous regime, he argued was 'very sensible' and not too administratively
complex, and allowed for a more neutral treatment of capital gains.
Mr Cameron Murray also turned his attention to the CGT discount,
recommending that it be abolished altogether for residential property, or at
least limited so that it only applied to property held for more than ten years.
The CGT discount encourages speculative investment in residential
property and merely amplifies the housing cycle. A much longer qualifying
period, or the removing of the CGT discount from residential property would
reduce investors' willingness to pay for housing, and therefore make owner
occupation a more attractive choice.
Housing researchers from Swinburne University of Technology also
recommended removing the 50 per cent CGT concession for investment
Few of the issues raised during this inquiry were as contentious as
negative gearing. The committee accepts that negative gearing likely encourages
higher levels of investment in residential housing than would be the case if it
did not exist in its current form (for instance, if losses on investment
housing could only be deducted against rental income). This, in turn, likely
has a detrimental effect on home purchase affordability. On the basis of
evidence received during the inquiry, the committee was unable to clearly
determine what effect negative gearing had on rental affordability; it notes,
however, that most witnesses who spoke to the issue challenged the idea that
negative gearing helps contain rents, and some also argued that it actually
serves to undermine the availability of affordable rental stock.
The committee believes it is problematic to characterise negative
gearing as a tax 'loophole'—indeed, the deductibility of losses against
assessable income is a long-standing feature of the tax system in Australia. Popular
belief aside, negative gearing is not a feature specific to housing assets, although
it is overwhelmingly used in relation to investment housing.
Regardless, the committee is disappointed that Treasury was unable to
quantify the effect of the negative gearing arrangements on housing prices, or
provide clear guidance on the relationship between negative gearing and rental
With this in mind, the committee suggests that, as a minimum starting
point, an informed public debate about the taxation treatment of investment
housing requires a full and frank assessment of how negative gearing and the
50 per cent CGT discount affects house prices and the rental market.
This assessment would include the cost to revenue of negative gearing and the
CGT discount, and what impact, if any, these arrangements have on economic
productivity. The committee has also concluded that it would be useful for the
Treasury to provide a comprehensive assessment of the effect on purchase and
rental affordability of various possible changes to the taxation treatment of
investment housing. This assessment should also examine the administrative
practicality of various changes, and the effect such changes would have on
revenue and economic activity more broadly.
The committee anticipates that the taxation treatment of investment
housing will likely be addressed as part of the White Paper on the Reform of
Australia's Tax System. Any study by Treasury would necessarily have reference
to and, as appropriate, build on the policy directions set out in White Paper.
The committee recommends that, to the extent such matters are not
addressed by the White Paper on the Reform of Australia's Tax System, the
Treasury should prepare and publish a study of the influence of negative
gearing and the capital gains tax discount on home purchase affordability and
on the rental market (including the effect on security of tenure for renters),
the effect of these arrangements on revenue, and their effect (if any) on
economic productivity. This study should examine the likely effects of alternative
taxation treatments of investor housing. Alternative approaches considered in
this study (including, where appropriate, in combination) should include:
- a housing-specific 'quarantine' approach, wherein losses for
investment properties can only be deducted against rental income, with
provision for losses in excess of rental income to be carried forward and
deducted against future rental income and capital gains;
a broader 'quarantine' approach, wherein interest expenses on all
investments, including but not limited to housing assets, are only deductible
in any given year up to the amount of investment income earned in that year,
with provision for losses in excess of this amount to be carried forward and
deducted against future investment income and capital gains;
limiting the application of negative gearing arrangements to new
housing stock, or designated new affordable housing stock;
limiting the application of negative gearing to a certain number
of properties (assessing options for various limits in this regard);
options for phasing out negative gearing on investment housing;
applying the savings income discount recommended in the Henry
Review to investment housing, with consideration given to the impact of this
approach both with and without the implementation of the Henry Review's
recommendations in relation to housing supply and housing assistance; and
- reducing or removing the capital gains tax discount for
investment properties, or reverting to the pre-1999 system of taxing real
rather than nominal capital gains on investment assets.
Tax and the family home
A number of submitters argued that the exemption of owner-occupied
housing from CGT (and, indeed, state land tax, as discussed in
chapter five) encouraged overinvestment in housing as a form wealth
creation. As a result, house prices were pushed higher than they otherwise
would be, providing a benefit to existing home owners but serving to make it
more difficult for would-be first home owners to enter the market.
Owner-occupied housing in Australia is exempt from CGT and other income
taxes; further, as was discussed in chapter six, it is exempt from state-based
land tax. Professor Yates, in research cited in AHURI's submission, estimates
that the tax benefit to owner-occupiers was worth $45 billion in 2005–06.
The lion's share of this amount, $29.8 billion, is derived from the CGT
exemption. The non-taxation of imputed rent—that is, the rent which owners
would need to pay themselves if they rented their own houses at market
rates—accounts for $6.9 billion of the total.
The exemption of imputed rent from GST accounts for a further $4.8 billion
of Professor Yates' total, with the remaining $3.5 billion attributed to
the exemption of owner-occupied housing from state-based land taxes.
Referring to tax expenditures in relation to owner-occupied housing, the
CFRC noted that policy settings targeted toward support for home owners are
generally underpinned by 'contentions about the perceived economic and social
benefits' associated with home ownership. However, according to the CFRC, the
structure of indirect tax expenditures to owner-occupiers fails to assist people
into home ownership:
Instead, the greatest support goes to existing home owners,
with young lower income home purchasers and renters receiving the least
assistance. Indeed, given the contribution of such support to what some
analysts argue is a substantially over-valued market (OECD 2013), these forms
of assistance actively debar access to moderate income and lower income groups.
The implicit subsidies provided through the tax system benefit home owners, not
Mr John Hawkins made a comparable point, suggesting that the CGT
exemption cost the budget $30 billion per year, and in the process served
to entrench economic inequality:
As well as driving up house prices the tax treatment is
regressive, discriminating against those, generally poorer, people who spend
their lives as renters not owners.
Similarly, NT Shelter submitted that the preferential tax treatment of
owner-occupied housing—including the CGT exemption, the exemption from state
land taxes (as discussed in chapter six), and the exclusion of the family
home from the pension assets test (discussed in chapter twelve)—worked to the
benefit of existing home owners, rather than people seeking to enter the
While it could be argued that these advantages assist
moderate income households to access home ownership, it seems more likely that
their effect over the long term has been to inflate house prices and encourage
over investment in owner-occupied housing.
Professor Yates made the broader argument that tax expenditures on
housing, and in particular the exemption of owner-occupied housing from CGT,
raised issues of distributional and intergenerational equity:
Distributional analyses of these concessions highlight the
extent to which older, higher income households with high housing wealth
benefit disproportionately compared with younger, lower income households who
are most in need of assistance. The somewhat lower benefits for older, lower
income households are reinforced by the exemption of the family home from asset
testing for the age pension (higher income households are less affected because
they will be excluded by the income test). This provides an incentive for
households potentially eligible for the pension to maintain a high proportion
of their wealth in the family home in the same way as tax incentives encourage
older higher income households to do the same.
Taking a different view, Mr Eslake noted that while the family home was
exempt from CGT, it was also the case that taxpayers were not able to deduct
the costs associated with acquiring and holding the home. Mr Eslake wrote that
he did not favour the removal of the CGT exemption for owner-occupied housing
...consistency with other parts of the tax system would require
that mortgage interest payments be deductible. That would in turn almost
certainly encourage people to take on more debt, and would thus inflate the
demand for housing, putting further upward pressure on prices. And it could
well end up being revenue negative.
Professor Yates, however, noted that while interest expenses and
maintenance costs are not deductible, owner-occupiers are not subject to tax on
While not advocating the taxation of imputed rent, which she suggested was
probably 'unrealistic', Professor Yates did not agree that removing the CGT
exemption would require the introduction of interest deductibility.
The committee does not believe taxing capital gains on owner-occupied
housing would be constructive. While removing the CGT exemption could
potentially improve affordability, this would be achieved at significant cost
to home owners. Moreover, taxing the capital gains on a person's home would be
inconsistent with the broad community consensus that a person's home should not
be treated as simply another investment asset.
Navigation: Previous Page | Contents | Next Page