How tax breaks for investment properties have created a housing affordability crisis while lining the pockets of those least in need. By Mike Seccombe.

Negative gearing’s social carnage on low-income earners

David is just the sort of motivated, self-reliant bloke that our political leaders like to laud.

He had his own business for 30 years as a freelance graphic designer in Melbourne. He’d never been on welfare. He was a lifter not a leaner, to borrow the tendentious slogan of the Abbott government. 

Then his marriage broke up. He left for country Victoria, bought some land, planned to build a new house and a new life. He remarried and had a new family.

But things went bad. The land flooded, the work dried up. Now, at age 53, he has been on unemployment benefits for a couple of years.

He says he is “desperate” to find work, but David (not his real name) is stuck. There might be work back in Melbourne, but how would he afford the rent? Even the dilapidated old farmhouse in the country where he now lives eats up well over half of his meagre welfare payments.

“Like most people,” he writes, “we aspire to home ownership and to leave some kind of inheritance for our children, but I have come to see that in the current climate this aspiration is a mere dream for many people.”

He continues: “It’s not just a young person’s or a first-home buyer’s problem, it affects people of all ages – including older people like myself who have previously owned a share of real estate, but who have fewer working years remaining to better their situation.”

David is no fool. He has studied the analyses by welfare agencies and economists, the statistics from the tax office, and he knows exactly why housing is increasingly unaffordable, not just for welfare recipients and renters like himself but for millions of working Australians.

He understands that it’s caused by loopholes in the tax system that encourage, in his words, “greedy investors [who] compete with the poor and first-home buyers and create artificial demand, which in turn flows right through the whole housing sector”.

Treasurer Joe Hockey should know how the system works, both in his role as treasurer and through personal circumstance, given that his family owns several investment properties. Yet he continues to argue tax breaks given to property investors make housing more affordable, all evidence to the contrary.

Referring to negative gearing, through which property investors can claim as losses the financing and other costs of their rental properties against their other income, here is Hockey on Adelaide radio on Tuesday: “If you were to remove negative gearing you would see an increase in rents, and I think that hurts lower-income Australians who may be renting those homes.” 

Hockey went on to voice another contentious proposition.

“In fact,” he said, “most people who access negative gearing are middle-income Australians.”

The overwhelming majority of independent analysts argue both those claims are untrue. Saul Eslake, chief economist for Bank of America Merrill Lynch, goes so far as to call the latter assertion a “lie”.

1 . Housing stress

Back to David. He agreed to be a case study for the social welfare and charity organisation Anglicare’s 2015 rental affordability snapshot, released on Thursday.

“Snapshot” is really too small a term. It is actually a big, depressing panorama of unaffordability.

The survey covered 65,614 properties right across Australia. It used the commonly accepted benchmark of affordability, which is that when housing costs are greater than 30 per cent of the disposable income of a household in the bottom 40 per cent of income distribution, the household is deemed to be in “housing stress”.

Its findings are sobering. For a single person on the age pension, there were fewer than 600 properties in Australia that met the affordability criteria to rent. That’s 0.9 per cent of the total rental stock. For an age pensioner couple, 3.4 per cent of properties were found suitable.

For those on other kinds of welfare it was even worse. For someone on youth allowance, the Anglicare survey found eight properties. For a single person on Newstart allowance, there were 10. These are not percentages; they are numbers. Eight and 10 respectively of 65,000 rental properties in the entire nation were affordable.

Things were but slightly better for the working poor. Only about 2.3 per cent of all rental properties in Australia were affordable for a single person on the minimum wage of a little over $33,000 a year.

For a single parent with two young children, and therefore receiving family payments, the figure was 3.3 per cent. Even for a family with two young children, in which both parents worked for minimum wages, only about 24 per cent of properties were suitable.

The stress of paying high rents, says Anglicare’s executive director Kasy Chambers, means “people are going without things you and I would think non-discretionary, like car insurance, medication, a haircut for a job interview, maintaining the internet for their kids’ study”.

One of those items people went without was food, she said. “You can skip eating for a day, but if you don’t pay your rent you get thrown out. So food becomes a discretionary item. Over 65,000 Australians are living in food insecurity.”

Perhaps you can ignore the plight of the welfare dependent or minimum wage battlers trying to make the rent. Then think about yourself or your children. As David correctly notes, the affordability crisis affects a wide range of people, many of them much further up the income scale.

“There has been a big slide in home ownership for all households under the age of 55 over the past few decades,” says John Daley, chief executive of the Grattan Institute.

“Among those aged 25 to 34 it has fallen from 62 to 48 per cent over the past 30 years. For those 35 to 44 it has gone from 75 to 65 per cent. 

“Households on the lowest incomes have done particularly badly. But now even among more middle-income households, those in the second, third, fourth quintiles [i.e., those between 20 and 80 per cent of the way up the income scale], we’ve seen falls of five or 10 points in rates of home ownership among the 25- to 34-year-olds and the 35- to 44-year-olds.”

There are a number of reasons for this. The increasing disparity in wages, for one. More relevantly, rapid population growth through immigration, planning and zoning restrictions and growing numbers of foreign buyers have combined to increase demand and limit supply. 

But the big driver of inflated prices, the evidence shows, is speculative investment in rental properties, which has inflated prices.

Even for those of us who manage to buy into the market, this is a problem.

Just this week the credit ratings agency Moody’s released a new study of housing affordability in Australia, showing mortgage costs running at 27 per cent of income, nationally. In Sydney, the figure was above 35 per cent.

Affordability was the lowest it has been since 2008. In reality it’s actually much worse now, for in 2008 the official interest rate went to 7.25 per cent. Now it is a fraction of that: 2.25 per cent.

As interest rates have declined, buyers have simply loaded themselves with more debt. And if rates rise to any significant extent, many will have big problems meeting the cost. A 1 per cent increase in interest rates, Moody’s said, would see Sydney’s affordability decline “by 3.5 percentage points, which is the same as the impact of increasing house prices by 10 per cent”.

Applying the same affordability measure nationally it would increase by 2.7 percentage points.

Yet the property bubble inflates, driven substantially by mad speculation of investors. Increasingly people are taking out interest-only loans to buy real estate. The most recent data from the Australian Prudential Regulation Authority shows that 40,000 such loans were written in the December quarter of last year alone.

Clearly most of these people are not buying properties to live in; 35,000 loans were for investment properties.

2 . Rule changes

Negative gearing has long been a feature of the Australian tax system. But it was only in the late 1970s that investors started using it in a significant way to minimise their taxes by writing rental losses off against their wage and salary income.

In 1985 treasurer Paul Keating changed the rules to stop this, but the policy was reversed just two years later in the face of fierce opposition from the property sector, which ran the line that the law change was pushing rents up.

The argument was entirely specious, as has been demonstrated many times over many years by many economists.

The data shows that nationally rents actually rose much faster both before and after the Keating experiment in quarantining rental losses. But they did rise sharply with the policy in place – entirely coincidentally – in the Sydney market. Labor was desperate to win the 1988 New South Wales election, so it junked the change. It lost the election anyway.

The legacy of that capitulation has been to entrench the argument of the property industry that negative gearing helps keeps rents down, the argument that Hockey continues to trot out with monotonous regularity now as pressure builds to do something about the real estate bubble.

At face value, the claim appears to have some logic – that because they get a tax break, property investors do not have to charge tenants as much.

But John Daley says that is not true. Actually, it simply pushes up prices.

“Negative gearing in effect increases the return on a given dollar of rental income, which means people are prepared to pay a higher price for the asset,” he says.

But negative gearing is only half of the picture.

“The real problem,” says Australia Institute senior economist Matt Grudnoff, “came in 1999 when [treasurer Peter] Costello introduced the discount on capital gains tax. Before 1999, on average, rental properties made a profit.”

But the Costello cut in the capital gains tax suddenly made it vastly more attractive for investors to speculate on real estate, knowing that they could both claim their costs and losses as a tax deduction through negative gearing while they owned the property and reap a much bigger profit when they ultimately sold.

“The net loss from negative gearing just exploded after that,” says Grudnoff. “The net rental loss in Australia is close to $8 billion a year now, and growing fast.”

About a million Australians now own negatively geared properties, but the great majority of them are not, as Hockey claims, the mums and dads of middle Australia.

Analysis this week from The Australia Institute showed that: 

• 55 per cent of the benefit of capital gains discount and negative gearing goes to the top 10 per cent of income earners;

• households in the lower half of the income range reap only about 20 per cent of the benefits of negative gearing and slightly more than 7 per cent of the capital gains benefits.

Not only do the benefits flow overwhelmingly to the wealthy and cost the taxpayer – about $7.7 billion last year – they do little to increase the supply of rental accommodation. Some 93 per cent of investment goes into established properties.

Grudnoff would solve the problem by simply doing away with the tax breaks on negative gearing and capital gains tax.

Daley reckons the capital gains tax is the bigger problem: “The first best policy response would be to get rid of the capital gains tax discount.” 

If that were gone, the incentive to negatively gear would be substantially reduced, which would in turn reduce the cost of housing, improve equity and redirect capital into “productive investment in things that actually grow the economy,” he says.

Anglicare’s Kasy Chambers argues that negative gearing should at least be allowed only for socially desirable development.

“Negative gearing should be for new builds, or builds in a certain area, maybe builds of a certain size, and limiting it to, say, the first 10 years of a house’s life,” she says.

But Hockey and the Coalition government are not listening. They argue specious economics in defence of the status quo. And the real reason for their intransigence is not economic, it is political: the rich rentiers vote for them.

This article was first published in the print edition of The Saturday Paper on May 2, 2015 as "Negative gearing’s social carnage".

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Mike Seccombe is The Saturday Paper’s national correspondent.

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