Treasurer Wayne Swan has a tough road ahead. With Labor promising to deliver a balanced budget, he must find more tax revenue and fast.
Historically, when the federal government is in this type of predicament, they look for a way to rob Peter, pay Paul and attempt popularity damage control by targeting money making tax reform to small groups of tax payers – generally the wealthier ones.
So it comes as no surprise that many political commentators are suggesting the two areas on their hit list will soon be property investment portfolios and self managed super funds.
The great negative gearing divide
One of the biggest debates that keeps rearing its head is around the concept of negative gearing.
In its simplest form, negative gearing is when you use a loan to purchase an income-producing asset, like a rental property, and the costs of holding that asset – including the interest paid on the loan – produce a loss. In this instance, the investment is classified as negatively geared.
The idea that people can buy an investment property and then claim the out of pocket expenses associated with holding the investment has long been a contentious one.
In fact negative gearing has been demonized as causing a great deal of social and tax inequity amongst Australians, with critics blaming the fact that investors are allowed to claim interest on investment loans for any number of perceived problems including;
- Bumping up the cost of rental accommodation to unaffordable highs
- Housing affordability issues, and
- Billions of dollars in lost tax revenue, among others.
Why the ability to claim the interest on loans used to fund a property investment purchase as a reasonable expense is so widely criticized is a bit of a mystery really.
Current tax legislation does not make specific, special allowances for property investors with regard to negative gearing. It merely follows the basic principles of our entire taxation system, which is that costs incurred to earn an income are tax deductible.
In fact whenever a loan is required to buy an income producing asset, whether it is a rental property, office equipment or a piece of machinery, the interest on that loan is automatically claimable as a tax deduction.
Why not negatively gear?
Negative gearing is often perceived to be a way for “rich” Australians to dodge tax and cheat the system, rather than a fundamental part of our tax principles.
But the right to claim interest as a tax deduction is something that investors and income earners in many developed countries enjoy, including the British, Canadians and Americans among others.
Taking away the tax incentives to purchase negatively geared property would be a very unpopular move by the government.
When Hawke and Keating hit investors with a double whammy in the eighties, limiting the tax deduction for interest up to the value of income produced by property and introducing capital gains tax, the result was a critical shortage of rental accommodation that saw rents skyrocket.
Just two years later, with their tails between their legs, Labor’s brains trust was forced to reverse the decision. But a lot of damage had already been done.
The negative impact of banning negative gearing
As a result of 1985’s negative gearing ban available rental property stock all but dried up and the building industry experienced a massive decline.
In fact it could be argued that this short sighted, knee jerk attempt to raise revenue by the government was what started the housing undersupply we have in Australia today, along with subsequent affordability issues.
Not only were Labor forced to reinstate the tax deductions associated with negative gearing, they had to shell out more money in the form of a new tax deduction for the cost of constructing income producing property, in a bid to entice developers back into the housing market.
Fast forward almost two decades later, and today’s Labor government have obviously forgotten the old adage that, “those who cannot learn from history are doomed to repeat it”.
Taking such a drastic step to bump up their coffers would be a big mistake for the government to make. Far from addressing affordability issues, targeting negative gearing would have devastating impacts, not just for future generations of homebuyers, investors and tenants, but for the government’s bottom line.
As Australia’s aging population grows, it is critical for the government to encourage people to invest in property and superannuation so that they can support themselves financially in retirement. To take away incentives to do so is a shortsighted mistake that we can only hope they avoid.
I’ve written about negative gearing before – you can red this blog – Why negative should not be abolished and Peter Wargent’s blog – If negative gearing is scrapped what would that mean for property investment.
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