Why Labor's negative gearing policy might be bad for everyone: Part 2

In my last post, we reviewed the Labor Party’s stated policies concerning negative gearing and the capital gains tax. We highlighted the risk that the design of the policies would likely cause a surge in demand for property ahead of the July 2017 implementation date – pushing up prices rather than improving affordability.

Now it’s time to look at the potential and likely effects of the policies on rents, house prices and the wider economy post-July 2017 (when they would come into effect):

The post-July 2017 effect

Following the initial surge in prices preceding the introduction of the policy in July 2017, investors entering the market after this date would experience higher after-tax expenses on established properties that they acquire, and reduced CGT concessions on any future sale of those properties.

In other words, the cost of ownership for property investors would be higher – as many previously deductible expenses that could be paid in pre-tax income would need to be paid from after-tax income.

What does this mean in real terms?

Here are the numbers:

As of November 2015, the ABS estimated the average adult in full-time employment was earning around $78,000 per year – placing them in the 32.5 per cent marginal tax bracket.

Meanwhile, the average negative gearing loss reported to the ATO in the 2012-13 reporting period was $9,558.

Based on these figures, the cost of owning a typical negatively geared investment property stands to rise by $3,058.56 per year under Labor’s proposal to abolish negative gearing.

That’s $58.82 per week.

Or around 3.9 per cent of the average full-time employee’s weekly budget.

Although it may seem like a relatively minor amount – and that ‘rich landlords’ are an easy target – landlords aren’t a bottomless pit of money.

The extra $58.82 per week has to come from somewhere.

The push effect on rents from landlords

Since property investors only have a limited amount of income with which to pay property ownership expenses, the likely effect of pressure on investors may be a push factor on rental prices – as investors put pressure on rental managers to increase rents in an attempt to recover these higher ownership costs.

This stands to affect potential home owners who are currently renting – reducing the amount of income they can save towards the all-important home deposit (which is perhaps the BIGGEST factor affecting affordability – not the actual repayments on a property).

Plus, it stands to affect those who can LEAST afford it – those who are on low incomes and currently renting.

The pull effect on rents from renters themselves

The majority of property sold or rented in the market isn’t newly built. Instead, it’s established property.

People who rent typically want to live somewhere convenient – close to where they work, where the kids go to school, and near the amenities and activities they enjoy (cafes, shops, sports facilities etc.). They don’t often want to rent in new housing estates on the fringes.

And this tax plan provides a disincentive for investors to buy established houses and make them available for rent.

Over time, the this policy will make fewer houses available for rent where renters actually want to live – hitting family homes in established suburbs the hardest (and possibly directing investment towards already oversupplied new apartments in capital city CBDs and new housing estate developments in outer suburbs).

This stands to create a lack of rental supply in established areas.

As Economics 101 tells us, low availability (low supply) and strong demand means high prices, as tenants compete for increasingly scarce housing stock.

Impact on established property values

At the same time as rents are rising, it’s possible that prices may fall for these established properties. Especially in areas where a high proportion of properties are owned by investors, when they attempt to resell their properties but other investors might not be so willing to buy.

These drops would not just affect investors – but also existing home owners in these areas too.

This is the flip side of the affordability debate: making established property more affordable to new home buyers means making it less valuable for existing home owners and investors.

It’s worth noting here that for most Australians, their home is their single biggest asset and contains most of their wealth. The potential impact on established home owners’ property values seems to have been glossed over in Labor’s policy, but could be a grave concern to many voters.

While prices might fall to some extent, I’m certainly not suggesting that this would burst any imagined ‘property bubble’ or that property prices would go into free-fall and drop 30 to 50 per cent, as some sensationalist articles have claimed recently.

A more likely scenario in most established areas would be a levelling out of prices or more modest falls.

And if values do drop in established areas, the combination of lower prices and higher rents will mean higher rental returns. This will mean better cash flow from landlording – which would make the idea of investing in established property more attractive for investors, over time encouraging investors back into those markets (competing with first home buyers and defeating one of the claimed purposes of Labor’s policy). Eventually an equilibrium would be reached and prices would likely begin rising once again.

‘Brakes on the wider economy’

Imagine an Australia where taxes were higher, rents were higher and home values were lower.

Would you be likely to spend more? Or spend less?

It should come as no surprise that when taxes and rents are high, and the asset value of property is low, people are left feeling poorer.

The consequences of this are:

• Consumer sentiment turns negative
• People are reluctant to spend or invest in the wider economy
• And economic growth slows down.

I’m no fan of negative gearing as an investing strategy, but experimenting with the tax regime in a way that can adversely impact economic growth is best left for times when the economy is growing strongly, not times when the economy is struggling or undergoing a major transition, as it is today.

Following the end of the mining investment boom, it would be extraordinarily dangerous and economically irresponsible to introduce a policy designed to make people feel poorer.

This policy could have a much bigger (and quite adverse) impact on the economy than simply boosting affordability for first home buyers, or collecting more tax revenue from investors.

So – does Labor’s policy stand any realistic chance of delivering on the promised benefits, or have the policy-makers based their ideas on fundamental mistakes and fatally flawed assumptions that are disconnected from economic reality?

In the next entry we’ll ask the important questions:

• Will this policy actually benefit first home buyers?
• Will this fuel a construction industry boom?
• Is the extra tax revenue hoped for by the government just a pipe dream?

… and issue a ‘final verdict’ on Labor’s proposal.