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Tax breaks to blame for rising house prices

TheAustralian.com.au


The government has ignored Ken Henry's prescription for more affordable housing

EVERY time the Reserve Bank of Australia raises interest rates, Wayne Swan expresses his deepest sympathy for hard-pressed Australians with mortgages. For example, when they went up by another 0.25 percentage points this week, he said: "That's tough, that's difficult and unfortunate for many families and small businesses."

His concern is touching, to be sure. But it would sound more convincing if he did more to address booming house prices, which is one of the factors feeding into higher rates.

Of course, you'll never catch politicians criticising rising house prices. They would look too much like party poopers, given that higher prices are a cause for celebration for the 68 per cent of Australians who already own houses or are paying them off. Rather, they announce measures that pretend to do something about housing affordability, such as first-home buyers grants that feed directly into higher prices.

The Henry tax review thought it was better to get to the root of the problem. Its report says favourable tax and transfer provisions increase overall demand, particularly for owner-occupied housing. That is, exempting the family home from capital gains and land taxes means we tie up too much of the nation's income in housing compared with more productive areas and we drive up house prices.

But the report also acknowledges that no government is going to start taxing the family home. Rather, it suggests addressing the bias in investment housing towards negatively geared investment, which it describes as "a major distortion in the rental property market".

Another way of putting it is that it has become a national sport, or is that rort. The Australian Taxation Office says losses declared from negatively geared property grew by 35 per cent in 2007-08 to $8.6 billion. The losses, which are the differences between rental income and deductions, mainly interest payments, do not send too many property investors broke, otherwise 1.2 million Australians and rising wouldn't be plunging so eagerly into negative gearing.

Instead, they make a profit from rising property prices with the help of another tax break, the 50 per cent discount on capital gains.

While negative gearing and concessional capital gains taxes are by no means the only factors, they are hard to ignore as contributors to Australia's extraordinary property boom.

If negatively geared investment went mainly into new housing, you could argue that it was helping keep down prices, as well as rents, by adding to supply. Instead, 90 per cent goes into existing houses, meaning it is competing with people buying their own homes.

Since the restoration of negative gearing in 1987, there has been an increase from 8 per cent to 40 per cent in the proportion of finance for existing homes that is taken by investors.

The Henry review says median house prices have risen from three times to five times average household earnings in the past two decades. Figures collated by Macquarie Bank's Rory Robertson show house prices rising by 40 per cent in the past five years, compared with a fall of almost 20 per cent in the US.

We wouldn't want to wish the subprime debacle in the US on us but that's only part of the story. While house prices in Australia have tripled since 1996, in the US they increased by 70 per cent.

Comparing house prices with incomes, Australia has 12 of the 20 least affordable urban areas in a Demographia survey covering the US, Britain, Canada, Ireland, Australia and New Zealand. Vancouver comes top with a home price to income ratio of 9.3, with Sydney second on 9.1, followed immediately by the Sunshine Coast and the Gold Coast. Melbourne is in seventh place, Adelaide 10th, Darwin 13th, Perth 19th and Hobart 20th.

The Henry review proposes a 40 per cent discount on net residential rental income for tax purposes, which means the discount also would apply to deductible expenses such as interest. So those declaring a loss from a rented property would receive a deduction from their tax bills 40 per cent smaller than at present. Those nominating a profit would see their tax on their property income fall by 40 per cent. The present 50 per cent discount for capital gains would be reduced to the same 40 per cent figure, meaning a little more tax would be paid on the proceeds of sales. Interest on bank savings, which attracts no tax deduction, also would benefit from the 40 per cent discount.

Putting it all together, borrowing to negatively gear would become less attractive and saving more attractive. According to the Henry report, this "would largely remove the current bias towards negatively geared investment in rental properties and shares and so reduce a major distortion in the rental property market".

There will be much debate on the precise merits of this proposal. It is a milder alternative than the practice in countries such as the US of limiting deductions to the income from the asset itself, rather than from the individual's total income: that is, no negative gearing at all. But it is the product of considered and logical thinking by an expert inquiry conducted for 18 months, one, by the way, commissioned by the government. So how did the government react to the birth of the inquiry's labours? Not at all like a proud parent: it disowned it quicker than you can take a baby to the orphanage. Ken Henry's 40 per cent discount idea was on the long list of proposals that the government announced on Sunday would not be implemented "at any stage".

Perhaps we should not be surprised in an election year, though Swan certainly sounded as though he meant "never ever". When Melbourne ABC radio 774 host Jon Faine put it to him that negative gearing had a distorting effect on the housing market and the tax system -- which is no more than what Henry says -- Swan responded: "Well, I've never accepted that view and I think it would be economically disastrous to do anything on negative gearing and, indeed, that's what the review says."

Well, not quite. Henry certainly wants to do something about it, although he does suggest other measure should be taken first to improve the supply of housing, including removing stamp duties on home sales and reforms to land tax, and a significant increase in rental assistance to low-income earners.

The government has buck-passed these proposals to the states or ignored them. Considering it is lower-income earners who suffer most from high housing prices and high rents, this does not look much like the actions of a Labor government. As Reserve Bank economist Tony Richards argued last year: "As a nation we are not really any richer when the price of housing rises but the more vulnerable tend to be hurt."

In theory, an increased supply of land and homes will solve all the problems of the housing market. In practice, it is not as simple as releasing more land. For one, developers have to be willing to use it, rather than waiting for its value to go up further or for interest rates to fall. As well, much of the activity in the housing market involves competing for a limited supply of existing properties in desirable locations.

There is another constraint: if governments were really successful at increasing the supply of land and housing, it might bring down prices. No politician would be caught dead taking responsibility for that. But with the International Monetary Fund warning of the risk of a housing bubble and Australia a world leader in household debt and unaffordable housing, perhaps rising interest rates or other economic stresses will find their own drastic solution to the problem sooner or later.


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