the drum

Few positives to be found in negative gearing

The Drum

By ABC’s Michael Janda

Posted Mon 7 Jul 2014, 3:06pm AEST


Negative gearing and our pro-debt tax system may help the wealthier few but in the long run it could come back to bite us all. What’s worse, the Reserve Bank is handicapped when it comes to guarding against this, writes Michael Janda.

Last week I wrote about the Bank for International Settlements’ attack on its central bank members for their low rate policies.

In its annual report, the BIS warned that low interest rates were fuelling booms in financial markets and asset prices, even while lending to businesses and economic growth remained slow.

It called for central banks to stop printing money and start lifting rates back towards more normal levels now, rather than leaving it for later when a more severe and sudden adjustment may be needed.

But the BIS didn’t lay all the blame for surging asset prices at the foot of the world’s central banks.

“It also means designing a tax code that does not favour debt over equity,” the bank urged in its report.

And Australia offers one of the best examples of a country where the tax system favours debt.

The prime culprit is negative gearing.

Usually only featuring in public debate in its real estate context, the ability to write of interest payments against other income is not just available to property investors, but also to shareholders, businesses and other investors.

But it’s the real estate sector that probably generates the biggest threat to financial stability, and a drain on economic growth as investment is diverted away from businesses towards bidding up home prices.

The Grattan Institute estimates that real estate negative gearing costs the Federal Government coffers about $4 billion a year, which might fall to a saving of about $2 billion a year if it were abolished as people would change their behaviour.

But this figure grows strongly every year, as surging property prices mean ever more investors now make a loss on their investment property.

Property investment surge

The number of property investors has jumped from 1.3 million at the end of last century to nearly 1.9 million in the latest 2011-12 financial year tax statistics.

Landlords back in 1998-99 managed to turn a combined profit of $700 million. On face value, the new ones who have jumped in appear to lack the same financial nous, as their losses stand at just under $8 billion.

The vast bulk of those losses come from more than $24 billion in deductions for interest payments.

Let’s face it, if you’re paying more in bank interest than you’re earning from your asset year after year – whether it’s rent from property or dividends from shares – there’s only one reason you’re holding onto it, and that’s capital gain.

When an investor buys an asset mainly for capital gain with little regard to income flows that is speculation.

When lots of investors do it at the same time, that is a bubble.

Excluding refinancing, housing investors now make up roughly half the new home loans being issued by Australia’s banks.

That preponderance is also showing up in a shift towards investment loans as a proportion of outstanding home borrowing.

Starting at about 14 per cent in 1990, investors now make up more than a third of the balance of all outstanding home loans.

High income tax minimisation scheme

It’s probably no coincidence that the big surge in investment loans came in the late 1990s, around the time the Howard government changed Capital Gains Tax rules to institute a flat 50 per cent discount in place of the previous indexation.

That’s because it’s been the interaction between the new CGT system and negative gearing that has created the opening for tax minimisation.

By itself, negatively geared property is clearly a bad investment – even though other taxpayers are subsidising your losses, you are still losing money.

But add in the prospect of capital gains taxed at half your normal income tax rate and the whole system begins to make more financial sense – at least while property prices keep rising.

If the rise in value is big enough, investors can stand to make a lot more from the low-taxed capital gains that they lost from their taxpayer-subsidised interest payments to the bank.

From a social equity standpoint, RBA statistics show that while 23 per cent of households in the top-fifth of income earners have an investment property loan, only 11 per cent of households in the next highest income bracket do.

For those on middle incomes, only 9 per cent have an investment property loan, and the proportion of investment loans for low-income earners is unsurprisingly negligible.

That shows negative gearing is overwhelmingly skewed towards lowering the tax bills of the relatively well-off, not benefiting the average mum and dad battler.

That is unsurprising, as it takes a pretty high income to be able to sustain all the interest-related losses on your investment property while you wait for its value to go up enough that you can flog it for a worthwhile tax-discounted capital gain.

In the long run everyone will lose

But back to the BIS and its financial stability focus.

From that point of view, the big problem with this tax system is that it encourages excessive household borrowing, subsidised by the public purse, and going into an asset class that does nothing to add to the country’s productivity or economic outlook.

Much of this money in Australia is actually imported from overseas via our major banks raising so-called wholesale funding offshore – Australia’s big foreign debt problem is not government-related, it’s our mortgages being underwritten by overseas investors.

Australia’s tax system, almost uniquely favourable to those borrowing money, means the Reserve Bank is handicapped in setting monetary policy.

In weak economic conditions, it cannot lower rates as much as it might want to encourage business borrowing and economic growth because it knows that housing investors will instead be the dominant borrowers to bid up home prices.

In stronger times, it cannot raise rates as much as it might if tax policies were different because Australian households are so indebted that even a small lift in mortgage costs might tip many thousands into default.

It also means that millions of Australians – both the negatively geared investors and the owner-occupiers that had to pay too much for their home because of competition from them – are vulnerable to the slightest economic shock because so much of their income goes towards repayments to the banks.

The winners?

In the short term, the banks that profit off the rising debt and the real estate sector that takes bigger commissions and bigger development profits out of the surging property prices.

That’s why these two sectors squawk loudest when any changes to these pro-debt tax concessions are proposed, such as Paul Keating’s attempt to wind back negative gearing in the mid-1980s.

But, in the long term, these sectors stand to join Australian property investors and homeowners as losers when the capital gains stop and the losses begin to bite.

Michael Janda is an online business reporter with the ABC. View his full profile here.


A related topic:  “Property spruikers warned by mail

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So there they were with Tony Jones on the ABC’s “Questions and Answers” last night: Christine Wong, Joseph Stiglitz and Ross Garnaut, representing the voice of reason,

and Judith Sloan standing in for the rent-seekers (and probably most Australians).


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Anthony’s story deserves to go viral.

I don’t know you, Anthony, but good luck.  Australia needs people who can think for themselves, so you’ll be sorely missed as part of our “brain drain”.

Yes, many of Australia’s young people are nothing less than wage slaves: enslaved to ludicrously excessive mortgages. Either that, or locked out of access by extraordinary land prices.

Bon voyage!

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No, that’s where the profits are.  Who cares where the buyers come from?

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house bubble

The housing bubble and the pin factor

By Crispin Hull

Some economists and analysts have been saying for a decade or more that we are going to have a major slump in housing prices, and they have, according to real estate commentators and others, been proved wrong. But maybe the doomsayers have not been “proved wrong”. Rather, the predictions were a bit premature and/or we have already had a bit of a correction in 2008-09 with the global financial crisis, postponing the inevitable bursting of the housing bubble for a while longer.

Of course, before a bubble can burst, you must first of all have a bubble. A book just out called, Bubble Economics: Australian Land Speculation 1830 – 2013, by Paul D. Egan and Philip Soos, argues precisely this: there is a bubble and all the evidence points to it being about to burst.

Sobering stuff. Pitted against this is the view that Australian governments will continue to import more and more people into a finite residential land envelope, so continued increased demand will mean ever-rising housing prices. Egan and Soos examine earlier housing bubbles in Australia: the 1830s, 1880, 1920s, mid-1970s and late 1980s. Then they add a hard-headed analysis of the present housing market.

You need more than just rising prices to create a bubble, whether in housing, internet stocks or, indeed, tulips. You also need increasing private debt and a falling yield (as surging housing prices far outstrip comparable rents). To get a bubble these things have to rise quite quickly – at a rate faster than the rest of the economy to a point where the low yield rate and/or high indebtedness forces people to leave the market quickly, causing collapse.

Hitherto, the prospect of ever-rising house prices has meant the prospect of capital gains has held the market up, but, as Egan and Soos point out, it cannot go on forever, if the debt and low yields outstrip the prospect of capital gains. That defies economic fundamentals.

The statistics they present are quite forceful. Between the low in 1996 and apparent peak in 2010, real housing prices soared by 123 per cent (more than doubling) and they are getting back to 2010 levels now. Total land values relative to GDP doubled between 1996 and 2010, driven by rising residential land values. In the meantime, yields in the form of rent have fallen to just 1.9 per cent. The price-to-earnings ratio has blown out to 53. That means a $1 million house is returning just $19,000 a year, compared to $40,000 from the poorest fixed-interest deposit.

It means you need an awful lot of capital gain to make the housing investment worthwhile. There clearly comes a point at which the returns are too low and the expectation of capital gains too unrealistically high, so that people desert housing, or banks refuse to lend or demand their existing borrowers reduce their debt.

The only questions are how soon will that happen, and when it happens will it be sudden and large or gradual and incremental?

Egan and Soos argue that it will be soon, sudden and large, and point to the historical experiences, noting Mark Twain’s point that while history does not repeat itself, it does at least rhyme. Indeed, they point out the Australian housing bubble is bigger now than those in the 1920s, mid-1970s and late 1980s.

The present housing price-to-earnings ratio of 53 is interesting. The dot-com bubble in the US burst before the ratio got to 53 – it reached 47.2 at its peak. In that market, people expected dot-com stocks to always increase in price, just like Australian housing investors expect lots of capital gains, so they paid more for the assets than their returns suggested they were worth, until reality set in.

An interesting aspect to Egan and Soos’ work is that they take account of the owner-occupier part of the market. The yield for those dwellings is saved rent. There comes a point at which a person says it is better to rent than buy. You can borrow $1 million worth of capital in the form of a house for rent of just 1.9 per cent of its value. Pretty good deal.

We are seeing that with historic lows in first-home buyers and in lower rates of owner occupation. This can contribute to price collapse. The hidden pin in the bubble-bursting exercise is debt.

“Deregulation, privatisation and liberalisation since the end of social democracy in the 1970s has allowed the financial sector to lend freely,” Egan and Soos write. “The dire consequence has been the rise in the unconsolidated household debt to GDP ratio from 46 to a record 111 per cent between 1993 and 2010, lifting residential land prices far beyond economic fundamentals.”

They predict that high population growth and fixing the huge level of private indebtedness will probably cause a large decline in per-person income and production. They attack the standard explanations for ever increasing house prices, such as a housing shortage, high population growth, demographic change, falling nominal interest rates, a low rate of inflation, regulated land supply and foreign-investment controls. Rather, they argue, the real causes are debt-financed speculation and a taxation system that rewards speculators – a classic unsustainable bubble.

Their warning is grim: “Real housing prices may fall 30 to 50 per cent across the capital cities, devastating the economy and rendering Australia’s financial sector insolvent.”

One might well argue that negative gearing and political aversion to allowing housing prices to collapse will mean that there will be no bursting bubble. Also, the prospect of capital gains tax tends to make sellers delay sale until they get a favourable year for themselves with either capital losses to offset or a general low-income year.

Further, stamp duty; the time-consuming conveyancing process; and the requirement to sell the whole asset means that housing markets are not as susceptible to sudden collapses in the way sharemarkets are. But all that said, there comes a time when prices rise so high that these factors lose their force and the rational desire to make a reasonable return leads to the inevitable re-entry of economic forces.

It would be better for Australia if there were no bursting bubble but rather a gradual levelling out of housing markets.

To that end the government and the big lenders might well look at policies that favour productive rather than speculative borrowing.

Australia’s public debt is low, yet the government gets in a frenzy about it. Whereas our private debt is among the highest in the world, yet our government financiers just add fuel to the fire.

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michael short



The federal budget and its architects are as popular as a turd in a lunchbox precisely because they have failed to end some of the most egregious entitlements for the relatively wealthy, while cutting support for some of our poorest citizens.

- Michael Short, in THE AGE today.

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Straight talking from a billionaire.

Many thanks to IDEA economics for sending this article. They’re currently looking for Mr Hanauer.





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Usually I ensconce myself daily in front of my computer to tap out some of the more obviously bad financial news confronting Australia, to get it out of my system before getting on with my day, because the reasons have become so blatantly obvious to me. I can see it all ending as badly, or worse, for Australia than it did for the US, Ireland, Greece, et al.

Manufacturing continues to be replaced by speculative FIRE sector activity, which in turn has become cosseted and promoted by Australian governments. (“Aren’t we post-industrial anyway?”)

However, whilst the bad economic effects are indeed reported in the news, they tend to be reported as transitory events that will disappear over the horizon because “there is nothing structurally wrong with the economy.”

There is, you know: but efforts to get these structural weaknesses out to the general public are suppressed in the name of “maintaining confidence” in what any open mind would consider to be a doomed economy if they had all the facts. But the facts are difficult to get out in these circumstances.

Philip Soos and Paul Egan’s Bubble Economics: Australian Land Speculation 1830 – 2013 , worth thousands of dollars for its unique research data alone, should be a best-seller in economics. But what book companies would promote such a book in the current economic climate? It was therefore left to the World Economics Association to get it out on the web – for free.

bryan-macdonald-Much the same with Lindsay David’s book Australia: Boom to Bust. It happened to get a mention in a report on Australia by Bryan McDonald in Russia Today.

The inaction is frustrating – because if you don’t have all the facts about where the economy is failing, badly, the country will have no chance of repair before it disappears down the gurgler.




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blackstoneI am constantly overwhelmed by the depth of knowledge displayed by scholars and individuals in the sciences and humanities. From where came their essential inspiration, incessant determination and constant application to succeed so obviously in their field?

Whilst myriad discoveries from these people tend to progress modern society, the countervailing forces have become all too obvious.

I’ve read many erudite papers in economics and constantly felt let down. I do admit to becoming bewildered and lost in some of the mathematics, but then I’m able to get a pretty good sense of what a paper is trying to get across to me, and come away feeling underwhelmed, even cheated, from virtually everything I read in economics.

It is not an exaggeration to say much economics is bunkum, and even the maths is unable to serve and save it. (It often seems to compound the problem!)

Economics is the most overarching study of all.  People and the world constitute economics, but the study of economics has led us into a dead end.

Neoclassical economics currently acts as a deadweight that holds society and human aspirations back as it hijacks the rewards from work, knowledge and innovation, donating these to speculative rent-seeking parasites.

My 2007 report Unlocking the Riches of Oz: A case study of the social and economic costs of real estate bubbles 1972 to 2006 for the Land Values Research Group (on behalf of Prosper Australia), demonstrated in easily understood maths how we could double GDP and see to its better distribution in short order by tweaking our revenue system. Why is the study of economics not up for this?

The relatively few heterodox economists and other disciplines must call modern economics to order and to an intellectual rigour which accounts for economic rent.

We first need to understand the difference between public and private property–because economics currently breaches human rights–and the great lawyer William Blackstone (1723-1780) is a good starting point here:

The earth, therefore, and all things therein, are the general property of all mankind, from the immediate gift of the creator.

…there is no foundation in nature or in natural law why a set of words upon parchment should convey the dominion of land.

- “Commentaries on the Laws of England” (1766)

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By Mark Wadsworth –>






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