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Tax reform for affordable housing: Labor’s negative gearing and capital gains tax proposals

Posted by on February 18th, 2016 · Affordability, Construction, Housing


By proposing to restrict negative gearing to new-built housing and reduce the tax discount for capital gains, Federal Labor has presented a real policy platform for more affordable housing.

The high cost of housing in Australia – to buy, and to rent – is largely a product of our current tax settings, which favour highly-geared speculation in existing houses. At the Federal level there are, in particular, three tax settings that link together to have this effect.

First is the exemption of owner-occupied housing from capital gains tax (which encourages people with money to spare to throw it at their own housing… and at buying ‘investment’ properties that can be sold into the owner-occupier money fight).

Second is the generous treatment of negative gearing (which allows ‘investors’ to deduct interest payments and other costs of owning of rental property from non-rental income, making it easier to bear larger rental losses than they otherwise would – and hence take on higher levels of debt than they otherwise would).

Third is the 50 per cent tax discount for income from capital gains (which means that when an investor finally is taxed – on the sale of their property – they pay at only half the rate that would otherwise apply to their income).

Together, these settings have turned the housing market into the crucible of financial alchemy, where negatively geared investor incomes turn into lightly taxed capital. The result is big borrowing to pay big prices for established properties with capital growth potential (from uptrading owner-occupiers and other investors). The further result is that would-be owner-occupiers are priced out, and the shape of the rental market is distorted – with more high-value, high-rent properties, and more high-income renters – to the disadvantage of low-income renters.

Labor proposes to change two out of the three tax settings.

On capital gains tax, Labor would reduce the discount applied to income from capital gains to 25 per cent. This accommodates the idea that some part of a capital gain arises from general inflation and this shouldn’t be taxed, but it substantially narrows the difference in treatment between incomes from capital and incomes from work, rents and interest, and reduces the incentive to practice financial alchemy with loss-making assets. This reform would apply to across asset classes (rental properties, shares, fine art etc). (It might be noted: the Henry Tax Review recommended reducing the discount by 10 per cent (to 40 per cent) – less than as proposed by Labor – but would have applied this discounted tax rate to a wider category of ‘investment incomes’, including capital gains, rents and interest.)

On negative gearing, Labor proposes two things. First, for assets generally (properties, shares, etc), Labor would allow costs (eg interest) to be deducted only from ‘investment incomes’ (eg rent, dividends, capital gains) and not from other income (eg work). This quaranting of losses reduces the ability of investors to bear loss-making assets, and so reduces the amount of debt they can take on – and throw at assets – when they go shopping for assets. In the case of the housing market, this means less speculative demand, gradually leading to improved affordability.

But secondly, for a particular class of asset – newly built rental properties – Labor would make a special deal. For this  class of asset alone, the current generous negative gearing provisions would continue to apply, so costs would be deductable from all sources of income (rents, and income from work). This preferential treatment of newly-built rental property should encourage investment that actually adds to the housing supply – something all agree would help enhance affordability over time.

As regards both its negative gearing changes and capital gains tax changes, Labor proposes to ‘grandfather’ investments made before 1 July 2017. It is interesting to think about how this might play out. We might expect some investors to hang onto their properties in order to retain preferential treatment. On the other hand, as all of these investors will be holding something for which, post-1 July 2017, there will be less demand – ie second-hand rental properties – even the retention of preferable treatment regarding negative gearing and CGT may not be enough to cover the prospective shortfall in gains, and they may be moved to sell. Investors can be grandfathered from changes to tax settings, but not from changes in the market.

It is in the nature of speculative markets that downturns can come quickly and dramatically. The long-term prospect held out by Labor’s proposals is for sustained capital development in the housing market, with less of the damaging speculative dynamic that has made housing – whether owned or rented – unaffordable for many Australian households. It would also immediately open up scope for more public investment in social and affordable housing, as outlined in the 10-point plan to tackle housing unaffordability.

As the party in Opposition, Labor may yet change the nation’s tax settings – but it has already changed the public conversation, and increased the pressure on the Government to make a housing tax reform commitment of its own. Tax reform for affordable housing can happen in the next Parliament – or the Government can make it happen in this one.



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