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Labor's negative gearing heroics alone won't save us


It is not often that federal political parties exhibit courage. Labor's decision to change the rules on negative gearing is a rare instance. It targets directly what is most dangerous and unfair in our financial system. Expect howls of protests from powerful lobby groups if it ever looks like becoming policy.

Between Debt and the Devil: Money, Credit, and Fixing Global Finance by Adair TurnerThe implications of the existing negative gearing policy — in combination with former treasurer Peter Costello's decision to introduce a 50 per cent discount on capital gains — have been evident for some time.

Australia has some of the world's highest house prices relative to income. Household debt is 123 per cent of GDP, making the nation's households the most indebted in the world.

There is a massive generational divide between the older people fortunate enough to own their home and the young who have been priced out of the market. The split will have lasting social consequences.

It also makes the fate of the economy more precarious because far too much depends on one asset class, land. Not only is more than $3 trillion tied up in housing — about twice the value of the stock market — the big banks, which account for more than a third of the stock exchange, are heavily exposed to the residential mortgage market.

Australia is punting far too heavily on the continuing health of the housing market, whose fate becomes more uncertain as prices and debt continue to rise.

In theory, there is nothing wrong with negative gearing. It is simply the principle that the interest costs on debt are tax deductible, a rule that is applied widely. The argument of those defending negative gearing, that taking it away from property investment is discriminatory, has some validity.

But look a little closer and it becomes clear what the problem is. The logic of allowing deductibility on interest costs is that it is a way of enabling the flow of credit to encourage productive economic activity. That would apply to new housing investment, which has to be 'produced'.

But it is far less defensible when applied to existing housing (although renovation could be seen as 'productive') because it is really an investment in land value. Land is not 'productive'; it is unchanging.

The problems are not unique to Australia. They have been evident throughout the developed world, suggesting that higher house prices are as much to do with the behaviour of banks as with lax Australian tax policy. Lord Adair Turner, former head of the UK's Financial Services Authority, has said the GFC and the subsequent anaemic recovery has been caused by an addiction to debt. 

Turner, author of Between The Debt and the Devil: Money, Credit, and Fixing Global Finance notes that in 1950, private credit relative to GDP across all the developed economies was about 50 per cent. By 2007, the level had risen to 170 per cent relative to GDP.

When debt rises to that level, Turner says, it never goes away. It simply 'shifts around the global economy and the attempt for people to get out of debt, what we call de-leveraging, drives companies to cut investment, households to cut consumption and that drives economies into this post-crisis malaise'.

Turner estimates that in the developed world only about 15 per cent of bank lending funds new capital and investment. The majority of lending either fuels consumption — which has some limits as people run out of a capacity to repay — or a 'competition between businesses and households for the ownership of real estate assets that already exist'.

This leads to the kind of dangerous economic super cycles that we are witnessing.

Such heavy property lending, which has little to do with funding plant and equipment, or new ideas, or research and development, represents an indictment of the banks. Because of their obsession with collateral, they have actively catalysed, if not created, a global property gambling industry.

In this sense, Australia has simply caught the same disease that is afflicting most of the developed world. More than four fifths of Australian business loans have property as collateral, because local banks no longer have the skills and capability to assess what a business is really worth.

The bias away from productive investment is what the Labor's changes to negative gearing are designed to target, but this will not remove the attraction towards property. It will take a lot more than that to deal with the ills of the financial system.

Turner notes that negative gearing on property was removed in the United Kingdom, yet Britain still has soaring house prices. The real fault lies with lazy and ignorant bankers who have no interest in doing the hard work required to fund productive economic activity.

There is another reason that investment in property is considered so attractive. It is psychologically appealing in an uncertain world.

One of the consequences of the derivatives fiasco, which led to the near melt down of the monetary system in 2008 (derivatives are a layer above conventional 'debt'), is that many have lost confidence in money itself. Derivatives are valued at about $US630 trillion, three times global debt and about 800 per cent of world GDP.

In this bizarre environment, property seems more 'real' than other investments. Money itself has certainly lost some of its 'reality'. The impact of decades of reckless banking practices has, unfortunately, many dimensions.


David James

  1. David James is the managing editor of businessadvantagepng.com

Topic tags: David James, negative gearing



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Existing comments

There is a massive generational divide between the older people fortunate enough to own their home and the young who have been priced out of the market. The split will have lasting social consequences. ............................. Did I miss the bit that said that, in part, negative gearing is responsible for keeping first home buyers out of the market? A house bought as an investment, with interest and other expenses deemed to be tax deductible, makes a house, at point of sale, much cheaper for the investor than for someone who wants to buy a property to be their home and for whom the interest and all other costs are out-of-pocket expenses. I'm sick of the bleating that if negative gearing is axed then there will be fewer rental properties available. What investors are saying is that they don't want young people to be able to buy their own homes. They want them to pay rent, dead money to the renter, to fund the investor's lifestyle. When you're playing with one of life's essentials, a roof over your head, negative gearing on housing can only be seen as immoral.

MargaretC | 24 February 2016  

Precisely MargaretC, as another commentator put it the other day the current system helps the investor outbid the would-be home buyer so that the investor can then rent back the house to the buyer and pocket the rent income as untaxed income and, eventually, the on partly taxed capital gain. Talk about pay-day loan sharks.

Ginger Meggs | 25 February 2016  

It is a fundamental principle of our tax system that you can deduct expenses necessarily incurred in earning income. The tradie can claim the cost of his or her tools. If capital gains were not taxed so concessionally, we wouldn't be having this discussion. We should only be taxing real gains, so our cgt regime needs to allow for inflation. But the current 50% discount is too generous. The old indexation system was ok or we could allow a 2.5% discount for every 12 months of ownership. One should also remember that in the case of residential premises the tenant isn't normally claiming a deduction for the rent.

Roger Connery | 25 February 2016  

good analysis David. You put the blame where it belongs, though governments and their lax regulation also has a lot to do with it, especially in the US. President Clinton especially has a lot to answer for. It is also galling to realise how much money bankers have been paid to get us into this mess! However, Labour`s policy is too crude and will puncture the bubble too dramatically; it needs deflating slowly. I hope that the Turnbull governernment come up with something more sensible and calibrated.

Eugene | 26 February 2016  

"psychologically appealing in an uncertain world." There's the rub. Labour is right in principle, as David James has so clearly shown in his summary of its negative gearing and capital gains tax policies. His description of how the banks operate in this area is spot on. But all sweet reasonableness will be no match for a deceitful fear campaign that Labour's policies will lead to the value of people's investment in property will gradually lessen and lessen over time. Their nest egg will become an unproductive shell. It was a sorry sight to see Prince Valiant (PM Turnbull) using the same tactics of fear and dread as his usurped Black Prince (Mr Abbott). He may not have been throwing Molotov cocktails or planting Improvised Explosive Devices but the aim was the same - to spread fear and doubt and confusion among the people.

uncle Pat | 26 February 2016  

David, you analysis is very good and simply explained, but what about the solutions? I agree that negative gearing is not the only solution and that economic and political solutions are inseparable, so where should we start and who should start proposing the needed strong change? As you said "Australia has simply caught the same disease that is afflicting most of the developed world", and this means something very important, that any solution is going to be a fight against the current economic and political world, these "powers" are not sound but very very solid! Maybe a "House Party" could start the job?

Paolo | 26 February 2016  

What chance seriously is there of meaningful changes to NG when the Federal political class themselves have so much 'skin in the game'. 57% Senators and 54% House of Reps members own NG'ed investment properties. These tend to be in the highest value ares. A clear and present conflict of interest.

Suzanne Marks | 27 February 2016  

They're interesting figures Suzanne, and they explain a lot. Perhaps the solution is to return even more micro party senators?

Ginger Meggs | 29 February 2016