Positive solutions to the negative gearing issue

THE negative gearing policy debate mirrors Middleton’s Rouseabout, who ends up owning the station because he has no ideas.

THE ongoing negative gearing policy debate mirrors the situation of Henry Lawson’s and Slim Dusty’s Middleton’s Rouseabout who ends up owning the station because he has no ideas. Hopefully the next Treasury leader will switch the debate to real budget crisis issues.

Over the past few years Treasury has consistently argued that assistance to private superannuation is a huge budget problem and succeeded in reducing the maximum amount private individuals can contribute to about one quarter of previous levels.

At the same time, it has not focused on the massive growth in government employee spending, social welfare outlays and its own unfunded pension benefits.

The unlimited tax deductions for negative gearing don’t satisfy the need to encourage either domestic savings or efficient productive investment.

Limiting the benefits from contributing to super has caused even more tax-conscious investors to consider negative gearing strategies to reduce taxes and build wealth.

These tax arrangements allow investors to reduce their total taxable income by losing money on their investments because of the full deductibility of both depreciation allowances and interest on their debt. The government collects tax only when returns are positive or when the asset is sold at a profit. With appropriate estate planning, the capital gains tax can be avoided by astute investors forever.

The political reality is that it would be impossible to make any changes to negative gearing strategies and investments that are already implemented.

However, Treasury needs to focus on some sensible strategies to assist new owner occupiers to enter the market and encourage the building of new properties.

This involves reducing the huge advantage that investors have in purchasing existing and new properties.

Without properly targeted changes, property prices will continue to be inflated by investor demand and the cost of negative gearing will continue to soar in future budgets.

Over the years, Treasury has not proposed gearing reforms because of the political backlash from a botched previous attempt to change the rules. However, there are several changes that could cost-effectively help to increase the available housing stock and reduce costs for both homeowners and renters.

The first is to confine the availability of negative gearing, including the ability to prepay up to 13 months’ interest and expenses, to acquisitions of newly constructed residences up to a realistic maximum cap of say $1.5 million.

On resale, as in the US, the new owner would along with other new acquirers of existing properties be allowed to carry forward losses only to offset against future investment income including realised CGT.

This approach does not involve any retrospective changes for existing geared investment properties but if the budgetary situation needed it, the grandfathering of existing investments could be limited to a realistic time period such as 10 years.

Other countries have opted to limit the availability of deductions using minimum income tax provisions that only allow tax deductions up to a specified percentage of individual assessable income. This would not, however, encourage investment in newly constructed properties.

A third approach would be to mirror superannuation tax arrangements that limit the tax advantages for higher income taxpayers and thereby reduce the revenue cost.

For example, all tax refunds could be calculated using the lower of the taxpayer’s marginal tax rate or 30 per cent.

Changing CGT arrangements would also help limit the cost to the budget.

The exemption of 50 per cent of the realised gain from tax after one year of ownership rewards high gearing levels and reduces the advantage for investors who pay off or reduce their loans. And the ability to defer paying any CGT indefinitely by moving into a rental property or bequeathing it to children adds to the costs to the budget without helping to increase the housing stock.

Daryl Dixon is executive chairman of Dixon Advisory.

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