Change is hard, particularly in government. There are two types of political forces in the world. One is to change and hopefully improve society, and the other is to maintain the status quo. In the last election, the Labor party went to the election with a policy to cancel negative gearing. No longer would people be able to deduct expenses from a rental property from their overall income. The policy was soundly rejected. The status quo won.
The question is why was the policy rejected? There are probably a mix of reasons. Obviously, house investors would oppose such a change even though it was not retrospective. Perhaps they were thinking of future purchases not being available to negatively gear. Another group may be people who could see negative gearing as a good tax minimisation facility in the future. Others may have perceived such a change as “the thin edge of the wedge”. If they change this, heaven knows what else they may change about real estate.
To take a step back, the more people who own their own homes, the more stable society will be. In an article in Forbes magazine they identify various research studies that show higher homeownership provides more stability and a safer society. The conclusion is that it is a good thing and should be encouraged by the government. Unfortunately, there is an ever-growing financial hurdle to overcome before people can become owners.
I wrote a few years ago about the supply and demand side of homeownership, but there is another dimension to consider on the supply side. There is a constraint on building more homes due to several factors.
- There are constraints on land. Cities are running out of available land and are expanding away from the centre. This requires massive investments in infrastructure and services for the new areas and associated cost to the councils.
- There are constraints in labour. There are only so many electricians, concreters, plumbers and carpenters to do the work. There is no magic wand that doubles the number of skilled tilers or window fitters overnight.
- There are constraints in materials made worse by the supply chain problems created by covid.
One factor that is relevant is that many first home buyers are renters. If somehow we can get the investment homeowners to sell to the renters who are looking to buy a house, the problem can be alleviated. In other words, we need to encourage the investors to sell out of the market. Taking away negative gearing could be a good incentive.
If a flat proposal to cease negative gearing after a certain date was rejected by the electors, how can this policy be repackaged to make it palatable? I am not an economist, but here is a rough sketch of something that might be appealing enough to voters.
Call it the “Step Down Gearing” policy. All the numbers could be varied but here is the basic model. The policy starts with a phased elimination of negative gearing. Let’s say it is to be eliminated in 10 years. We start year one by saying anyone with more than 10 properties cannot claim tax benefits from the eleventh and subsequent properties. In year 2 we reduce the number to 9 until after 10 years there is no negative gearing.
This achieves two benefits. Firstly it impacts few people initially, and the public would see anyone with more than ten properties as wealthy enough to not be needing tax relief to provide support for their investments. Secondly, it provides a period of ten years for people who have multiple properties to divest their houses progressively and prepare for the eventual elimination of the tax break.
A second part of the new policy is that in year one, a person claiming tax breaks through negative gearing can only claim 95% of their expenses as a tax deduction. That also reduces by 5% per year until it comes down to 50% in the tenth year. As with the reducing number of properties, it reduces the tax benefit over a decade. It also provides an incentive to sell the property before the ten years is up, and a flood of the last investment properties comes onto the market.
Of course, there could be variations. Instead of ten years, it could be five or any number. You could apply it initially to anyone with more than five properties. Rates could be varied, or it could be done without a reduction of rates. The goal is to model the change and try to ensure a steady stream of investment properties come on the market over the period.
I am not an economist. There are people much more cleverer than this little black duck out there who could look at how it might work. It also relies on support from both parties or a new government could undo all the work as a sweetener to the electorate. A ten-year policy has a thousand ways to go wrong unless of course you are China who think long term. Maybe we should take a lesson from them.