Ross Gittins is excellent, as usual, in his latest piece on the housing bubble. He points out that most unit investors have put their own homes up as collateral and stand to lose them if prices decline sharply (say by 40 per cent). But I have a quibble about his conclusion, saying that, if this happens
the Howard Government’s reputation as incomparable economic managers might be looking pretty tarnished.
If so, it would have only itself to blame. Why? Because it left open the negative-gearing loophole on which this whole rocky edifice has been built. And then it compounded its failure by halving the tax on capital gains. I call that asking for a property boom. As Gittins explains, negative gearing involves taking tax-deductible losses on rental property in the hope of getting a capital gain taxed at half the normal rate.
The fundamental problem here is not the tax deductibility of losses but the concessional treatment of capital gains. In principle, at least, losses should be tax deductible. The practical problems are those of bogus losses and avoidance/evasion of tax on the associated income. But where possible, it is better to tackle these problems directly than to make particular categories of loss nondeductible.
The government certainly deserves blame for the decision, taken at the height of the dotcom mania, to halve the rate of capital gains tax. But Labor must share the blame for going along with this. As I wrote at the beginning of 2000.
Unfortunately, the Labor Party has decided that it can win the next election on the basis of the government’s difficulties with the GST, while proposing little more than cosmetic changes if elected.
Whether this is a viable political strategy is not for me to say. But it has already had disastrous effects on tax policy. In order to clear the way for a opportunistic campaign on the GST issue, Labor aided and abetted the government in destroying one of the Hawke-Keating government’s most important reforms, the taxation of capital gains on the same basis as other incomes.
The implementation problems associated with the GST will pale into insignificance compared to those that will arise from this cynical deal. The tax avoidance industry and the courts will be kept busy for years dealing with attempts to convert taxable income into capital gains. Moreover, the policy will favour heavily leveraged speculative investments at the expense of real investments generating taxable income. The danger of a speculative bubble, leading to an asset price boom and slump, will be enhanced. …. (emphasis added)
(The mysterious, and not entirely accurate, term ‘negative gearing’ can be parsed as follows. ‘Gearing’ refers to the ratio of debt to equity, which is approximately proportional to the ratio of interest payments to net returns. If interest payments exceed gross returns, net returns become negative, and the ratio becomes meaningless).
I’ve appended a bit more of the article below for anyone interested