Tuesday, March 25, 2008

Tuesday Column: Lets incentivate Australians... to lose money

It is true that Australia is just about the only country country in the world whose name rhymes with 'failure', but I mean, really!

As business people, Canberra residents make good public servants.

The latest tax figures show that around 31,000 of us are in the business of being landlords.

Taken together, we are not only not making money, we are losing a fortune.

ACT landlords lost $144 million from the business of renting during 2005-06, a performance all the more staggering when you bear in mind that six years earlier we only lost $38 million.

We appear not to be learning from our mistakes.

Perhaps you think this is an unfair way to describe the perfectly respectable, and ever more popular practice of negative gearing.

But it is the way the Tax Act sees it - as a way of making money gone wrong. Those of us who actually made money by renting out our properties will be taxed on those earnings. There aren’t many of us...

In only two of the ACT’s 25 postcodes do the landlords make money in net terms.

The rest of us who (accidentally or even deliberately) lose money renting out houses will be taken pity on.

Because we have unfortunately stuffed up and are earning negative income from rent, the rest of our income will be reduced for tax purposes, so that we are no longer as badly off.

Looking through the tax figures just released it is hard not to get the feeling that a provision originally introduced to cover an unusual and unfortunate circumstance has become mainstream.

This needn’t be a problem if it is providing the sort of incentive we want. But as a general rule an incentive that encourages someone to lose money is a bad idea.

And don’t doubt that money will be lost. When, as is likely, real estate prices turn down and there are no capital gains to be made to compensate, a good many of those 31,000 Canberra landlords are going to find their finances looking sick.

Nationwide more than one million Australians are now losing money as landlords – an extraordinary figure given the size of Australia’s population.

All up they are losing $8.7 billion.

It didn’t used to be like that.

Back in 1999 before a little-publicised but highly important change to the tax law there were only 650,000 landlords and they weren’t losing anything like as much.

In the midst of all the publicity about the impending Goods and Services Tax, the Treasurer Peter Costello more quietly commissioned another tax review. When it reported its guesses about who would win and who would lose as a result of the change it recommended were never made public - in contrast to guesses about the effect of the GST that were everywhere.

Actually its recommendation was more of less forced on it. Peter Costello gave the Ralph review of business taxation one very specific non-business term of reference.

He asked it to examine the scope for “capping the rate of tax applying to capital gains for individuals at 30 per cent.”

In fact the committee went further and recommended that only half of each capital gain be taxed - effectively cutting the rate of tax on the sale of houses and units and the like to 24 per cent.

Labor had no apparent problem with the idea, just as it doesn’t seem to now. The briefing papers it prepared for last year’s housing summit were actually rather funny. They listed a whole suite of reasons for declining housing affordability - including rising interest rates, slow land releases and the cost of building - but nowhere mentioned tax.

But Mark Latham, in 1999 a backbencher in self-imposed exile, saw things clearly and made some pretty accurate forecasts.

He told parliament that the cut in the rate of capital gains tax was “the thing that tax avoiders want. They want incentives to move out of trading income into trading assets. They want the opportunity for property and asset speculation in the Sydney land market rather than a taxation system which promotes value-adding in the information technology sector.”

The Macquarie Bank’s Rory Robertson also saw what was about to happen early.

He bought a rental property himself and then advised clients in a note that “since September 1999 it is almost as though the Australian tax system has been screaming at taxpayers to gear up to earn increased capital gains rather than to work harder to earn increased wages or salaries.”

Why bother earning money by producing something when you could borrow to the hilt to buy a rental property, make sure that your repayments exceeded your income from rent, cut the tax you paid on your other income along the way, and then sell the property for a very-lightly-taxed capital gain?

It’s a rort crying out for reform.

At various times the Productivity Commission, the Reserve Bank and Access Economics have said so.

And its getting worse. Throughout 2005-06 an extra 49,200 Australians got into negative gearing; 1,200 of them in Canberra.

The Reserve Bank has described the surge as “unprecedented, both in terms of previous experience in Australia and experience overseas”.

And don’t accept uncritically the argument that it has kept rents low. While negative gearing has encouraged individual landlords to charge rents low enough to lose money, its surge in popularity has also ramped up the price of rental and other properties as more and would be loss-making landlords tried to climb on board.

As well, any rents that it might hold back are likely to be those at the upper and middle sections of the market. Negatively gearing landlords want good properties, and tenants they believe will look after them. They are not in the business of providing low-income accommodation.

I am expecting the Rudd Labor government to move against negative gearing, despite its apparent timidity.

Rudd, Swan and the rest of the senior ministry are very serious about making sure Australia uses its scarce resources productivity. And there’s little productive about losing money.

A start would be to push the rates of tax on capital gains back up to the standard marginal rates. If at the same time the rate of company tax was cut, perhaps to as low as 20 per cent, money might start to flow instead to where it where it could actually make money.