Negative gearing? We are working on the wrong side of the decimal point

Hopeful Sydney-siders checking out the crowded rental market. Queues will lengthen should there be changes to negative gearing. Picture: NCA NewsWire/Jeremy Piper

Here we go again: changes to negative gearing and the capital gains tax discount are being floated even though Anthony Albanese rejects any proposals to do so.

Mind you, the Prime Minister had ruled out any changes to the stage three tax cuts, declaring that his word was his bond.

In the event, the Coalition’s stage three legislated cuts were junked in favour of what was seen as a politically more palatable version of income tax cuts.

Does it make any sense even to be talking about negative gearing and capital gains tax at this point? Is it a case of working on the wrong side of the decimal point? Are there much bigger issues affecting the way the economy is operating and the impact on the public?

Let’s run quickly through the facts related to negative gearing. They have been discussed at great length for far too long.

There is absolutely nothing controversial about having a tax code that provides for the deduction of expenses associated with investment. Indeed, it is essential that this provision exists lest investment and the associated capital accumulation are discouraged.

That some investors, and not just in property, lose money and are able to deduct the losses from other taxable income is also uncontentious.

On the latest figures, there were about 1.1 million negatively geared property investors claiming a total of $7.89bn in deductions, yielding a tax benefit for them of $2.7bn. (There are about the same number of positively geared investors.)

In the context of the federal budget (total receipts now close to $700bn), we are talking small beer.

Moreover, any change to the rules would almost inevitably involve grandfathering of existing investors, so any gain in revenue would be insignificant, at least for several years.

Let’s be clear on another point: negative gearing subsidises renters. If investors were unable to use the losses to offset taxable income, they would have no choice but to put up the rent.

Sure, some might sell up, but many renters are not able to buy properties.

When it comes to the capital gains tax discount, again there is nothing controversial about imposing tax on only the real (adjusted for inflation) component of the gain. When the tax was first introduced by the Hawke-Keating government, there was a complicated formula to estimate the real gains that was then replaced by the Howard-Costello government to simplify the arrangement. The discount of 50 per cent for assets held for longer than 12 months became the rule.

Now one may quibble whether 50 per cent should apply for assets held for two years compared with assets held for 20 years, but the simplicity of the arrangement is the real value.

Bear in mind that any realised capital gains must be brought to book in the year of the transaction, meaning that even investors on relatively modest incomes are often pushed into the top marginal income tax rate of 45 per cent plus 2 per cent Medicare levy.

Any change to the capital gains tax discount would have to be grandfathered, which would mean any gain in government receipts would be relatively small. It also would create a lock-in incentive as people hold on to assets subject to the old, lower capital gains tax. This itself would cause economic harm.

In fact, the biggest capital gains tax concession, if you want to call it that, applies to the exemption of the family home. Treasury estimates that the revenue forgone of this exemption plus the discount on the tax is close to $50bn a year.

This figure has been growing rapidly in recent years along with house prices.

Let’s face it, it would be a brave government that proposes a capital gains tax on the family home. Should it do so, consistency would require the deduction of expenses associated with buying and running these homes. In other words, that’s not going to happen. The only conclusion is that sweating the small stuff such as tinkering with negative gearing and the capital gains tax discount has little economic upside, if any, but potentially large negative political consequences. While it’s easy to express outrage at the small number of negatively geared, multiple-property owners, the reality is that most investors hold only one property and many of them are middle-income earners.

The often intense disapproval of negative gearing is really derived from the objections that some people, including Greens supporters, hold to the accumulation of wealth. That some people are rich and use their money to purchase properties (and other assets as well) is somehow regarded as unjust, which is then conflated with the negative gearing provisions.

What, then, are the big issues that this government should be addressing? There are two and they are related. The first is the woeful performance of productivity and the second is the rapid burgeoning in the size of the public sector.

Productivity is now where it was in 2016. Picture: iStock

Taking the first: according to the recent national accounts, productivity is now where it was in 2016. Labour productivity fell by 0.8 per cent in the June quarter alone. Even the downward revisions that the Treasury made in relation to productivity growth – in the Intergenerational Report, for instance – now look wildly optimis­tic.

Just in case you think all advanced economies are being hit with productivity slumps, take the case of the US. Between 2014 and now, labour productivity in the US has increased by close to 15 per cent. Here, the growth has been 1.5 per cent.

Given that productivity growth is the engine for higher living standards, our performance on this score is worrying. It also is why the Reserve Bank will need to delay cutting the cash rate because of the lack of supply responsiveness to demand pressures.

Public sector demand essentially has exploded since Covid. From a figure of 22.5 per cent of GDP before the pandemic, public sector demand will reach 27.3 per cent this year because of actions of the federal and state governments.

This reallocation of resources within such a short period is essentially unprecedented, although it does mimic the temporary mining boom that occurred in the middle of the first decade of this century. At least with that boom the results were more production and more privately funded infrastructure.

In today’s case, the ramp-up in public spending is replete with higher recurrent payments and higher public sector wages. In political terms, this sort of spending is difficult to reverse. It is directing resources into low-productivity activities – the Treasurer likes to call it the care economy – and crowding out private sector initiatives that otherwise might be implemented.

Forget the distraction of negative gearing and capital gains tax – the issues have probably been raised only because the government has achieved absolutely nothing in terms of economic reform. There are some significant perverse developments noted above that the government is ignoring or making worse.