Removal of Negative Gearing Would LIFT Home Ownership

More evidence that negative gearing should be revised was contained in a preliminary paper released recently, having been discussed with the RBA in November. Melbourne University researchers Yunho Cho, Shuyun May Li, and Lawrence Uren suggest their modelling shows that the removal of negative gearing would potentially lift homeownership rates by 5.5%, and that “renters and owner-occupiers are winners, but landlords, especially young with high earning landlords, lose”. They stress this is preliminary, but nevertheless it adds to the weight of evidence that negative gearing should be reformed. Their data also again shows how a small number of affluent landlords are benefiting disproportionately at the expense of the tax payer .

The welfare analysis suggests that eliminating negative gearing would lead to an overall welfare gain of 1.5 percent for the Australian economy in which 76 percent of households become better off.

This is significant, given the annual government expenditure
on negative gearing is estimated to be $2 billion, or 5 percent of the budget deficit for the year 2016. Eliminating negative gearing would reduce housing investments and house prices, and increase the average home ownership rate. The supply of rental properties falls, rents increase but only marginally because its demand also falls.

The data in their report also underlines the significant growth in property investors, and the consequential rise in mortgage lending and negative gearing.

The left panel in Figure 1 shows that the proportion of landlords has risen by around 50 percent over the last two decades. The right panel in Figure 1 shows that the real housing loan approvals have also increased dramatically during the same period. In particular, the loan approvals for investment purposes increased more sharply than that for owner-occupied purposes, surpassing it by around $0.5 billion in the early 2010s.

Figure 2 documents the proportion negatively geared landlords and the aggregate net rental income across the period from 1994 to 2015. The left panel in Figure 2 shows that the proportion of negatively geared landlords has increased from 50 percent in 1994 to around 60 percent in 2015. The right panel in Figure 2 shows that the aggregate net rental income became large negative from the early 2000s onwards. Evidence shown in Figures 1 and 2 suggest that Australian households increasingly participate in the residential property investment and take advantage of negative gearing, reducing tax obligations with the flow loss incurred from their housing investment.

Figure 3 compares the share of households with home loans for investment by age (left panel) and income percentile (right panel) for the years 2002 and 2014. There has been a significant increase in the share, particularly among young to middle-aged households.

The largest increase was occurred in the age group 25 – 35, increased by 85 percent from 7 percent to 13 percent. From the right panel, we find that the share of households with investment housing loans has increased mainly among those in upper income percentiles.

These evidence are in line with the arguments by opponents of negative gearing that the policy essentially benefits the rich households who borrow and speculate in the property market. The fact that the distribution of housing investment loans is different across age and income also motivates our use of a heterogeneous agents incomplete markets model to study the implications of negative gearing.

This is consistent with our own surveys and analysis on negative gearing. Good data and analytics can negate political rhetoric, even it takes time…!

Finally, of course is the important point, should interest rates rise then the value of negative gearing claimed will rise, putting a heavier burden on the Treasury, at a time when the cost of Government borrowing would be also rising. A double whammy – a multiplier effect.

Treasury memo misses the real impact of Labor’s negative gearing policy

From The Conversation.

Labor MPs might be rubbing their hands together with glee at a Treasury memo that shows the federal opposition’s negative gearing policy will have a “small” impact on the property market. But insights from behavioural public policy, as highlighted by the 2017 Economics Nobel laureate – Richard Thaler and his colleague Cass Sunstein, tell us that how people respond to this policy will be more about how the government frames it.

The Treasury memo showed the Labor policy of limiting negative gearing to existing homeowners will have a limited impact as the changes are unlikely to encourage investors to sell quickly. Also, owner-occupiers dominate the housing market and the costs of selling are high.

However, this assumes that people are forward-looking, well-informed, good with numbers and perfectly responsive to new information. Behavioural economics shows us that people do not always think so deeply and logically about their choices.

How any changes to negative gearing are sold to us – as a loss or gain, as a one-off or ongoing, in terms of short versus long term costs and benefits – will impact how Australians react.

Most of us aren’t whizzes with mathematics. As Nobel prize winner Herbert Simon has shown, in place of complex mathematical algorithms we use heuristics. These are simple rules of thumb that draw on our intuitions, experience and gut feel.

Heuristics and biases

One common example of a heuristic is the availability heuristic. This is when we make decisions based on easily available information such as recent events and highly emotive experiences. Our brains work better with narratives and stories than with facts and figures.

Nobel economics laureates George Akerlof and Robert Shiller have applied a similar insight to analyse people’s perceptions of housing market fluctuations. They noted that we hear lots of stories about how house prices are on an upward trend. Via the availability heuristic, we easily remember these emotionally engaging stories, much better than we can remember the dry facts about the history of house price instability and housing market crashes.

This leads us to overestimate the chances of continuing house price rises, and to underestimate the chances of a fall, driving unsustainable house price increases – as witnessed, for example, in the American sub-prime property markets before the global financial crisis.

While heuristics can help us to decide quickly, they sometimes lead us into systematic mistakes – “behavioural biases”. This does not mean that we’re all hopelessly irrational. But for negative gearing it matters how a potential change is framed, and how that fits into our heuristics and biases.

Most economists (including those at Treasury) assume that one dollar is a perfect substitute for any other dollar. Whether we save A$100 via a tax break, win A$100 from a scratch card or earn A$100 from working overtime, it makes no difference.

Contrary to this view, behavioural economics has shown that the way we treat money is different depending on the contexts in which we earn and spend it. We have different “mental accounts” for consumption, wealth, regular income and windfalls. We are more likely to splurge money we’ve won from a scratch card than money we’ve earnt doing overtime.

This is another reason why framing is important. How the government frames a negative gearing change will determine the mental account to which we assign it, and therefore how we respond.

If negative gearing changes are considered a one-off hit – the opposite of a scratch card windfall – then property owners won’t worry so much. On the other hand, if the change to negative gearing is seen as an ongoing drain on our incomes, then they will worry a lot.

Another factor that will come into play is loss aversion – people are much more likely to worry about losses than gains. Evidence from behavioural experiments shows that home-owners over-estimate the value of their properties. This makes them reluctant to sell at reduced prices in a falling market.

It also means that Australians will resist negative gearing changes if these are framed as a loss, creating political pressures for a policy u-turn. It is difficult to predict how people might respond, but behavioural economics shows that any ructions might be avoided if the negative gearing change is framed as a gain.

For instance, Treasury predicts that the additional revenue raised from restricting negative gearing could be up to A$3.9 billion. Therefore, the negative gearing changes could cover more than 80% of federal government expenditure on veterans and their families.

In the long and short term

Treasury’s modelling notes there might be downward pressure on house prices in the short term from changing negative gearing, but that this will be small overall.

But a range of models and experiments have shown that people are disproportionately focused on tangible, short-term outcomes. For example, most of us find it hard to persuade ourselves to go the gym: the short-term costs are inconvenience and discomfort and the benefits seem intangible and distant. This is called “present bias”.

Recent work in behavioural economics confirms that framing (alongside a range of other socio-psychological influences) has a strong impact on our choices. Framing will determine how we perceive the policy, which mental account we will use to process it and how the various heuristics and biases identified by economics and psychologists will play out.

In the debates around negative gearing policy changes, these behavioural insights have not been highlighted. So perhaps Treasury could have added some psychology, alongside the economics, in arguing that house price falls are likely to be limited.

Author: Research Professor at the Institute for Choice, University of South Australia

The Fall Out From The Negative Gearing Expose

The FOI release, which the ABC covered yesterday, highlighted “the Coalition’s phoney defence of negative gearing and capital gains tax discounts before the last election”.

A number of economists at the time disputed the claims that winding back those two tax write-offs would “take a sledgehammer” to property prices because “a third of demand” would disappear from the market.

But as the excellent Rob Burgess has highlighted in the New Daily today, there are two consequential questions which need answering:

The two questions that need answering, is why were Mr Turnbull and Mr Morrison making such obviously false claims, and why were those claims not torn apart by the Canberra press gallery?

The answer to the first question is straightforward. They were either responding to an ideological commitment from the right-wing of their own party room that tax is somehow optional for asset-rich Australians, or they were following the advice of party strategists who could not see them re-winning government if wealthier Australians did not hear them loudly condemning Labor’s plans.

Historians will not doubt tell us which of those it was in years to come.

The answer to the second question is more complicated.

Journalists were not brazenly siding with the banks who had profited so much from the negatively-geared property investment mania, and they were not simply playing partisan politics in favour of a Liberal-led government.

Rather, the get-rich-quick culture of the then 16-year-old property boom, and the gradually normalised claim that tax avoidance is somehow a basic human right, has infected Canberra policy makers and fourth-estate critics alike.

That’s why in 2016 it was so refreshing to hear NSW planning minister Rob Stokes lay out the moral case against these tax write-offs.

He said at the time: “We should not be content to live in a society where it’s easy for one person to reduce their taxable contribution to schools, hospitals and other critical government services – through generous federal tax exemptions and the ownership of multiple properties – while a generation of working Australians find it increasingly difficult to buy one property to call home.”

While he told the truth, his federal colleagues were telling lies.

They lied on behalf of the 10 per cent of Australians who profit from the tax write-offs, and against the interests of the other 90 per cent.

Perhaps now that the nation’s best-equipped economic modellers have highlighted the benefits of these reforms – around $6 billion a year returned to the budget bottom line – the news media will finally call these laws out for what they are.

They are grossly unfair. They have helped pump up the Australian housing bubble. And they have redistributed tens of billions of dollars from poorer to wealthier Australians.

As interest rates start to rise around the world, and the interest-payment write-offs of property investors start to bite even harder into the federal budget, these laws need urgent reform.

A news media that vigorously holds the defenders of these laws to account would be a good start.

Proposed Negative Gearing Changes Only Minor Impact

The ABC is reporting that a Treasury  FOI request has shown that Federal Labor’s negative gearing overhaul would likely have a “small” impact on home values, official documents reveal, contradicting Government claims the policy would “smash” Australia’s housing market.

The previously confidential advice to Treasurer Scott Morrison from his own department said the Opposition’s plan might cause “some downward pressure” and could have “a relatively modest downward impact” on prices.



Negative gearing exposing Australia’s poor: KPMG

From Financial Standard.

KPMG warns any increase in Australia’s historically low interest rates would cause serious economic problems and affect households across the entire financial spectrum, from rich to poor.

The industry consultant said one of its biggest concerns is that Australian households have progressively increased debt levels at rates faster than their disposable incomes have grown.

Most notably, KPMG economists highlight some of Australia’s poorest citizens are taking on negatively geared property investments when there’s a clear inability to manage the financial risks.

Analysing the incomes and spending of Australian households over the past 20 years, KPMG said household income has primarily grown because of investment income and government transfers, not rising wages and salaries.

The firm added that more than one-third of the income of the poorest 20% of Australian households is received through government transfers.

Its report finds the bottom 20% of households recorded the highest rate of growth in investment income, at 8.5% per annum, compared to an average of 2.3% over the past decade for other households.

KPMG Australia chief economist Brendan Rynne said: “While it is perhaps understandable that the poorest members of our society want to diversify and increase their incomes, this group is the least able to take on the financial risk associated with geared investment activity.”

The second 20% of lowest-income households, or those slightly better-off, are getting relatively more than the lowest bracket in terms of (government) dollar transfers received per dollar tax paid. KPMG said this suggests policies to deliver welfare to the poorest members of society are less effective than to slightly better-off recipients.

“The proportion of households that end up paying no net tax – but via an administratively costly money-go-round of paying income tax and then getting it all or more sum back via income support payments, has now reached 60%,” Rynne said.

He says the answer is not further ratcheting up marginal tax rates for higher tax earners.

“Our analysis shows that the top 20% of households already pays 50% more income tax than the bottom 80% combined,” he said.

Federal government may cap number of investment properties

From The Real Estate Conversation.

The federal government is considering limiting the number of properties investors can buy, as it struggles with ways it can reign in property prices in booming markets only a few weeks out from the May budget.

According to an article in The Australian Financial Review, the government is looking at ways it can cap the value of tax breaks for property investment as it tackles housing affordability problems, which vary widely around the country.

Since 2012-2013, there has been a 9.2% increase in the number of property investors that own five or more properties, according to The Guardian’s analysis of recent Australia Tax Office data.

The federal government has ruled out getting rid of negative gearing according to Labor’s policy, and has indicated that it will consider more ‘surgical’ measures.

The government appears to have moved away from an earlier idea to allow first-home buyers to access their superannuation funds to accumulate enough money for a deposit.

Malcolm Gunning, president of the Real Estate Institute of Australia, told SCHWARTZWILLIAMS the percentage of investors in the market that own three or more investment properties is only very small, and therefore capping the number of properties those investors can own is only “clipping around the edges”.

Gunning said capping the number of properties investors could own would mainly be “political posturing”, and warned it could decrease the supply of new properties coming onto the market, which in turn could cause rents to rise.

“It’s a balancing act,” said Gunning.

Negative Gearing In Action

The ATO released their summary FY15 data this week, and included quite comprehensive summaries of the range of costs those with rental properties have offset income. They also divide rentals into those functioning at a loss, and those who make a profit.

Of the 2.9 million rentals, 1.1 million made a profit, the rest a loss (which can be offset against other categories of income). That means 60% of rentals are under water.

We can also see the categories of costs claimed and the average amounts. Not all households claim all categories.

Significantly, the major factor between loss and profit is the interest amount. Those reporting a loss had bigger interest payments (presumably larger loans?). But it is also worth looking at the 20 categories (yes 20!!) which can be claimed. Behold the wonders of our generous tax system, and the reason why so many do not want it to stop.

More On Negative Gearing Distribution – The Wealthy Benefit The Most

Last week we discussed data from our core market model on negative gearing, and using our segmentation demonstrated that some, and more wealthy segments, benefit the most.  There is room to trim the excesses, without necessarily removing gearing overall.

Today we look at another perspective, which supports this argument. We estimate that 61.7% of households with investment property are negatively geared – this has been rising significantly, as investment property penetration as risen.  Around 2.4 million households hold investment property, but not all is mortgaged or geared.

The first chart shows the value of investment property mortgages mapped to the value bands of investment property held. The orange area are households who negatively gear, the blue those who do not. This shows that the larger value portfolios have more gearing, and therefore get the greater tax benefits.  Note also the small, but important peak in portfolio values above $2m. We are seeing the rise in the “professional” investor class, or Portfolio Investors as we call them.

Another way to look at the value distribution is by the number of properties held in the investment portfolio. Again the orange area is property negatively geared, the blue, not geared.  We see a significant spike in gearing above 5 properties, as well an an expected strong distribution in one or two properties. Our modelling shows around 79% of households have one or two properties.

The overall costs of negative gearing and capital gains tax concessions are an estimated $7.7 billion annually, and three-quarters of the capital gains tax concessions are enjoyed by the top 10 per cent of income earners.

So, in our view, the Government should be looking to curtail the gearing available to multiple property holders, and limit the total amount which can be geared. Those two simple measures would take heat out of the market, reduce the tax burden and still allow “mum and dad” investors to benefit.

A categorical “NO” to negative gearing reform is a major mistake. Treasurer, please note! As it stands, as mortgage rates rise, and investment loans will bear the brunt of these rises, actually the poor tax payer pays for this, insulating geared investors from the extra costs. Treasury should be modelling the extra impost this will be on the budget.


Investor Property Footprints And Negative Gearing

The argument trotted out to defend negative gearing from reform is that the bulk of investors are “typical mum and dad” households.

Of course it depends on how you look at the data, but lets look at output from our core market model.

What we have here is the relative VALUE distribution of investment property held by our core household segments, based on marked to market values.  We see that whilst some households in most segments are represented, the relative value is massively skewed towards more wealthy segments. Exclusive Professionals, our most wealthy segment holds 27% of all investment property by value, Mature Stable families hold 18%, Suburban Mainstream 15% and Wealthy Seniors 9%.

Another way to look at the data is through the lens of our property segmentation. Here investor only segments (they have no owner occupied property) hold 33% of investment property. Within that Portfolio Investors who hold multiple properties hold 3% by value. Those holding property but with no plans to move – Holders – have 20% by value, whilst those trading down hold 19%.

When we look at households by employment type, we see that employed workers hold 62% by value, whilst 17% are help by those not working, 10% managers, 9% expert professionals, and 2% by executives.

But if we look at the use of negative gearing, we see that three segments, by value have the largest footprint. Exclusive Professionals have 42% of negatively geared property, Mature Stable Families 27%, and Wealth Seniors 14%. Other segments are much less likely to negatively gear.

Looking again by Property Segments, Investors and Portfolio Investors have 32% of all negative gearing by value, but other segments also use this technique.

From this we conclude that it is important to separate the holding of an investment property from the use of negative gearing against that property. In fact we think negative gearing is predominately used by more affluent households, and they get the biggest tax breaks as a result, which of course other tax-payers have to subsidise.

There is, in our view, overwhelming evidence that curtailing the excesses in negative gearing (for example, a $ limit) would assist in cooling the market and inject needed cash into the budget.

But as we pointed out the other day, if the political agenda wins out, this just will not happen.

First Scramble the NBN, Now Housing

The AFR reports today that Scott Morrison is advocating increasing supply as the recipe to solve the current housing issues, and is standing firm against a crescendo of calls to curb negative gearing tax breaks (though may be more amenable to capital gains changes).

I was reflecting on the current state of play, given RBA, APRA, ASIC (three members of the Council of Financial Regulators – the Treasury being the fourth) are all underscoring the risks in the housing sector. Investors are in the firing line.  Logically, negative gearing should be curbed.

But then I started to consider the political agenda, and wondered if there are parallels with the second class service the current NBN solution is delivering; at least to me. Essentially, Turnbull wound back Labor’s fibre to the end-point solution by arguing that there was a better, cheaper, quicker way. It became do anything BUT what Labor proposed. The result, in my case at least is a slow, unreliable NBN solution, unable to deliver acceptable bandwidth at peak times, and no upgrade path. The political battle may have been won, but the end outcome is frankly horrid. As a digital business we suffer the result every day! The cabinets on the local street corners (now daubed with tags and grafiti) will be a lasting tangible monument to a politically catalysed outcome.

But, now, are we seeing the same with Negative Gearing changes, which Labor proposed, and which have been opposed by the Government ever since?  Has it become caught in the same trap as the NBN? Had Labor kept it’s power dry, would we have seen changes to negative gearing already?

Could it be that on principle, the Government won’t concede this to Labor, and so will literally go round the houses to avoid changes to negative gearing?

This despite the many calls, from responsible and well informed sources who say that it is the tax breaks which are driving the investment property sector. This is also confirmed in our surveys.

Will the legacy of the unwillingness to tackle such a core element in the landscape cost us a housing crash? As we argued recently, it is looking more likely that we will need a correction to defuse the current heady trends.

But if the needs for a political wins outweighs good policy, it is highly likely we will get the housing equivalent of the NBN. We think Australia deserves better.