Negative gearing is one of those topics that has become a favourite 'whipping boy' for many, the latest being the NSW Minister for Planning. Like others, the minister claims the 'removal' of negative gearing is the solution to the housing affordability crisis. Those making such claims seem undeterred by the fact that the 1985 experiment in this area by the then “World’s Greatest Treasurer”, proved to be a failure at that time.  

As an opening premise, I would suggest that few understand what negative gearing is, and I suggest the use of the word 'removal' is misleading. But misinformation is the order of the day and few seem prepared to accept that the proposed changes would result in the imposition of a penalty or dare one suggest, 'a big new tax' on a select group of taxpayers.  But we will explore that assertion later in this essay.

The problem is that all the discussions fail to deal with ‘first principles’. Too often the banter descends rapidly into people arguing if it will or won’t have a negative impact on the economy and/or homeownership. And each side readily produce 'evidence' to make their case, getting mired in arguments about details while the real issues is overlooked.

The debate usually starts with someone talking about the 'evil' that negative gearing creates, then the discussion moves onto the cost to the federal budget. The 'evil' is usually portrayed in two parts:

• It is claimed as being responsible for evaporation of the 'Australian Dream' of home ownership; or
• It is a concession to 'fat cat' investors, in the guise of medicos, big end of town investors or other equally heinous beings.

The cost is portrayed as:

• A special 'benefit' which costs 4, 6, 10+ billions of dollars per year to the Federal Budget bottom line. The figure varies depending on the dramatic affect being sought.

All emotive issues to be sure, but here is the thing. If you go looking in the Tax Act for the section on negative gearing that the naysayers want removed, you will have a problem. Why? Because there is none. So, what then are we actually talking about. 

The term 'negative gearing' appears to have arisen as an accounting expression. In simple terms, it is used to explain how to deal with losses; YES losing money.  The most common use of the term is in relation to an investment in property where the rent does not cover the interest and other costs of ownership. Dead boring, right!  So how did this topic reach such an elevated status, requiring such persistent and often nonsensical conversations? A little more background.

While there is no reference to negative gearing in the Tax Act, there are general provisions relating to deductions you may claim. Now this article is not meant to be a technical analysis of the Tax Act, as I am neither an accountant nor a financial advisor, so check with your own experts. The applicable fundamental issue, as it has been explained to me over the years is this. If you expend money on items that relate to the generation of income, then you can claim a deduction. Most will be familiar with the fact that if you earn an income then, at a personal level, you can generally claim some form of tax deduction for costs relating to your job which has the effect of lowering your tax bill.  Thrilling isn’t it!  

Further, if you have a business where you employ people and have a premise, then the relevant general provisions of the Tax Act allow you to claim a deduction for things such as rent, wages, stationary, phone etc. Of relevance, is the fact that interest on a loan used to purchase equipment for the business is claimable as a tax deduction.  

Now let us take a simple example of a wage earner or a contractor earning an income and paying tax at their appropriate rate. Let us say they have saved some money and have it invested in a bank. Rather than have it sit in bank, their financial advisor or accountant may suggest that they invest in property. The shift of funds from a bank deposit to residential property may be explained in terms of the client entering the business of property investment.  

So, our tax payer buys a house and is now a property investor, in addition to being a wage earner and/or contractor. Just like every other business, our investor is advised that the Tax Act will allow them to claim certain deductions in relation to their new enterprise. This means they will be allowed to claim a tax deduction relating to some of the costs in respect of the purchase and retention of this property. Further, any loss between the income (rent) and the outgoings (expenses) can be offset against the income that our tax payer earns. I note that the largest expense in terms of a property purchase is often the interest on funds borrowed to assist an investor purchase a property.   

The claiming of a tax deduction for the loss between income and outgoings will most likely be explained in terms of 'negative gearing'. As already noted the fancy name and tax treatment does not alter the fact that to get the “benefit”, you must suffer THE LOSS. The simple fact is that the process is nothing more than claiming legitimate expenses, like all businesses are permitted to do. Doesn’t seem extraordinary there is so much carry on about an investor losing money?  

In the public discussion to date, the utter dullness of the process that leads to a claim covered by the term negative gearing, is never addressed. What is discussed are the 'evils' and the claimed financial impact.  But if we go down this path one can ask, why then are not other areas of legitimate tax deductions put under the microscope? Why is it just losses relating to residential property?  

What is the budget impact for say, wages? Now it is absurd to think about the wages bill for say Coles or Woolworths being selected as an item that they can no longer claim as a legitimate business expense.

So, the obvious question then is, what is it about a person running a property investment business that makes them special and in need of being penalised for claiming a legitimate loss.  

It is not the intention of this dissertation to pursue the political machinations that led to the selection of property investors as a group to be punished, but political expediency is no doubt in the mix. To this end, I offer an interesting juxtaposition. Let us say our investor was presented with the option of investing in shares or in a property in Sydney. This will be fun! 

If you are buying a property for any reason, you pay stamp duty (tax) for the 'right' to purchase. But there’s more. Our investor will also pay land tax on the value of the land, once it reaches a threshold value. So, our investor is paying the State Government for the privilege of purchasing a property in the first place. And, if the land value of the property is more than $550,000, bingo! you are allowed (sorry, required) to make a further annual (Land Tax) contribution to the NSW Treasury for the privilege of ownership. Heaven forbid our investor is successful and ends up with more than one investment house.

If that is the case, then the land value of all properties is added together to calculate the $550,000 threshold. And OMG if you become really successful at this property investment thing, because, you guessed it, the rate goes up. A penalty for success - Marx (that’s Karl not Groucho) would be very pleased. 

Now what if the same investor were to buy shares and he borrowed money to purchase those shares.  And say the shares failed to make enough money to cover the cost of the interest on the loan, what would the picture be? You know right:

• You can claim the loss between the income and the interest cost as a tax deduction without comment;
• You pay no stamp duty on the purchase;
• There is no ongoing penalty paid to the government for the right of ongoing ownership of the share portfolio;

So, should we ask who is really getting special treatment? And why does the negative gearing discussions never include shares listed on the stock exchange?

Irrespective of the political posturing, I suggest that there is no legitimate reason to penalise people trying to legally invest their money in a chosen asset class or am I living in a different Australia? And as for the investors, many are mum and dad investors seeking to create a nest egg for their retirement. Many would have probably lost faith in the share market.

I am sure that someone knows what is really behind this push for penalising property owners but I find it outrageous. As for the comment about the 'big end of town' I think I can suggest that such folk are more likely to invest in the share market, not residential property. I leave it to you dear reader to ponder that one.

So, if there are no specific provision in the Tax Act in relation to negative gearing, what would be required to implement the removal of the 'benefit'? Rather than removing some special privilege, as it is often presented, what would be needed would be legislation that would allow for the imposition of a what could only be termed a penalty on one section of the community. A penalty is usually a punishment that someone is given for doing something wrong or against the law. So, what is it that property investors are doing that requires them to be penalised with what would effectively be a big new tax. The only 'sin' I can see is that of thrift. Prudence wasn’t on my list of heinous sins at catechism classes.  

Why don’t we ever hear about the USA model to assist with home ownership. That is where the interest on your home loan for your personal residence can be claimed as a tax deduction against your personal income. Would this not improve affordability rather than chasing some ephemeral discredited concept of taxing those seeking to save for their retirement. Just a thought.

The primary objective of this treatise is to suggest that attributing blame to a select group for the housing crisis and for damaging the budget bottom line, is unfair. Especially in the context that this minority group are for the most part hard working individuals who have done nothing more than use the general provisions in the Tax Act that are available to and used by most taxpayers. With respect, I would also like to suggest to the NSW Planning Minister that he and his cabinet colleagues hold the power to address the biggest issue, the perennial disparity between demand and supply. Unfortunately minister, if you have been advised that this has minimal significance then you have been poorly advised. I would be happy to disavow you of your current considerations.

See also:

Malcolm Turnbull says 'no' to negative gearing changes

Baird agrees negative gearing is important in affordability debate

Scott Morrison says negative gearing rules will stay