What's the deal with negative gearing?

June 18, 2015
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You’ve heard the term bandied across the political arena like a game of buzzword shuttlecock, but what does ‘negative gearing’ actually mean? Joe Hockey says it a lot, so it either has to be a brand of cigar or something that can be viciously hurled at the poor (although I suppose that doesn’t preclude cigars).

Australia’s political climate is baffling enough without these cryptic terms, so we’ve put together a handy guide to help you make sense of this latest rhetorical hot potato.

What even is negative gearing?

In Australia, if you buy a rental property but the rent money you receive from said property isn’t enough to cover the cost of owning it (which includes insurance, maintenance, loan repayments and other property-related expenses), you can write off the difference as a tax deduction. So even though a landlord might be losing cash to their property on a monthly basis, come tax season they get a sweet break.

But why would anyone buy an investment property that’s going to lose them money?

Usually it’s done in the hope that either the rent will one day be enough to cover the cost of ownership (making the property “positively geared”), or that the value of the property will increase enough to yield a profit when sold. Claiming the tax deduction also reduces your amount of taxable income, which can be pretty handy if you sit in one of the higher tax brackets. The whole thing is a rather generous arrangement that comes straight out of the federal budget.

How does it affect the housing market?

The government (namely Tony Abbott and Joe Hockey) claim that allowing negative gearing creates more rental properties, thus increasing the volume of available housing. While this is good in theory, the truth is that most investors are more concerned with making a tidy profit than solving the housing crisis, and only 7.1 per cent of property loans are for new houses.

Because negative gearing increases monthly expenses, it reduces short-term buying power; this means that it’s often not as useful for the less wealthy. It is for this reason that it’s sometimes labelled a tax-rort for rich people – indeed, most people who own negatively geared property are in the top 40 per cent of income earners. Furthermore, by making it easier for people to engage in property speculation, negative gearing gives investors an edge over first home buyers. And because it’s arguably a magnet for rich folk, many of the people these home-buying newbies will be bidding against are likely to have deeper pockets.

Negative gearing provides an incentive for people to own property they’re never going to live in, thus driving up housing demand while reducing the number of available houses. And in economic theory, when demand goes up and supply goes down, price tends to skyrocket.

Abolishing negative gearing

Joe Hockey famously stated on Q&A earlier this year that repealing negative gearing would see a massive increase in housing prices, as happened in the 1980s in Sydney, when Bob Hawke abolished the practice (which was later reinstated, of course). But as Hockey’s fellow Q&A guest, economist John Daley, pointed out, housing prices during this time only went up in Sydney and Perth, remaining relatively steady throughout the rest of country. And it’s likely this had more to do with a supply problem than the lack of negative gearing. This is because, Daley noted, if you reduce speculative property purchases, the people buying houses are likely to be the ones living in them; in this case, supply goes down, demand goes down, and price remains unchanged.

Housing prices aside, there are also fears that getting rid of negative gearing would cause large – if only relatively short-term – market disruption. This would mainly be because investors who rely heavily on negative gearing would no longer be able to afford their properties, therefore causing a massive rush to sell. While this increase in supply would probably cause a large drop in housing prices, it would also take a couple years for the market to regain its balance after such a dramatic seesaw. For this reason, it’s been proposed that any change to negative gearing policy be phased in over a number of years.

What are we doing about it?

The benefits of both negative gearing and its banishment remain hotly debated, but with housing affordability reaching crisis levels, there’s no question that something needs to be done. Both the Greens and Labor are pushing for changes to negative gearing, while certain members of the Liberal party deny the housing bubble’s very existence. 

Joel Svensson

Business major, journalism minor and sometime voice-actor, Joel Svensson pretends to be smart at La Trobe University in Melbourne.

Image: Andrea Castelli, Flickr Creative Commons license