Negative Gearing Redux

Abstract

hould the interest paid by landlords on loans used to finance the purchase of rented houses and apartments be tax deductible? There is widespread agreement that interest payments should be deductible at least up to the amount of the landlord’s ‘net rent’ — meaning the actual rent, minus all expenses other than interest payments. In this paper, we revisit Australia’s controversial ‘negative gearing’ (NG) arrangements, under which investors can also deduct negative cash flows — defined as the excess of interest payments over earnings net of depreciation and other non-interest expenses — from their other taxable income. We focus on NG of investments in rental housing, but the principles apply also to other investments, such as equities and bonds. Apart from a brief hiatus in 1985-87, NG has been a feature of the Australian tax system for many years. It is one of the few exceptions to Sieper’s dictum that, ‘[t]ax law is as inclined to deny tax-payers full loss-offset as economists are inclined to recommend it’ (Sieper, 1986:286). Indeed, it is a double exception: not only does Australian tax law allow it, but many economists and other commentators have recommended that it should be denied, on the ground that it is a tax loophole designed to steer revenues away from the Treasury. For example, Colebatch (2003) states: Tax Office statistics show that in 1999-2000, 54 per cent of rental housing landlords claimed to be operating at a loss. They wrote off their entire rental income against tax, plus $3 billion of losses, saving themselves tax of more than $1 billion — which in effect, is then paid by other taxpayers. Criticisms of NG have recently been intensified by the view that it has also contributed to an unsustainable property boom. Gittins (2003), for example, refers to ‘the negative-gearing loophole on which this whole rocky edifice [the property boom] is built.’ The Reserve Bank of Australia (2003) has noted that Australia’s tax treatment of rental property is out of line with that in other developed countries and has urged ‘others more expert in tax matters than the Bank’ to examine ‘those areas where the treatment in Australia differs from that commonly seen overseas.’ In fairness, it should be noted that the Bank’s submission to the Productivity Commission Inquiry on First Home Ownership, from which these comments are taken, makes it very clear that they recognise the general validity of NG. Their