December 21st, 2014
David Murray's Financial System Inquiry (FSI) continues to divide Australia, with everyone from the big banks through to individual home owners potentially affected. In addition to 44 recommendations, the Inquiry has also addressed 13 tax arrangements that it says distort the allocation of funding and risk in the economy. Negative gearing is one arrangement in the firing line, as the Inquiry warns of excessive growth in Australia’s mortgage debt. With the current state of negative gearing, investors are effectively offered tax breaks on the cost of investment properties. ; If the cost of owning an investment property, including interest on mortgage repayments, is greater than the rental income on that property, the loss can be used as an offset against other taxable income. ; While this is obviously great for investors, according to the FSI, it creates a risk for the wider financial system while also pushing prices up and disadvantaging first home buyers. The final report of the FSI has just been released, with implications for capital gains tax discounts, the dividend imputation system, and shareholder funding. ; Warnings about the risks of negative gearing have received the most media attention, however, as investors, owner-occupiers, and renters all wrestle with the implications of possible changes. ; According to the report, a combination of high tax rates on savings and generous tax concessions like negative gearing have made housing investment too attractive for the wider economy to stomach. From the report: ; "Since the Wallis Inquiry, higher housing debt has been accompanied by lenders having a greater exposure to mortgages. Housing is a potential source of systemic risk for the financial system and the economy… ; Australia’s banks are heavily exposed to developments in the housing market. Since 1997, banks have allocated a greater proportion of their loan books to mortgages, and households’ mortgage indebtedness has risen. ; A sharp fall in dwelling prices would damage household balance sheets and weigh on consumption and broader economic growth." "It would also reduce the quality of the banking sector’s balance sheets and the capacity of banks to extend new credit, which would compromise the speed of a subsequent economic recovery… ; This concentration, combined with the predominance of similar business models focused on housing lending, exacerbates the risk that a problem at one institution could cause issues for the sector and financial system as a whole." According to Matt Grudnoff, senior economist with the Australia Institute think tank, negative gearing and capital gains tax concessions are a major factor behind the surge in house prices. ; “Negative gearing is a tax break that primarily benefits the wealthy,” he said, adding “Most houses are sold at auction, and about half there will be there to buy the house in order to rent it. Almost all of those would be for the purposes of negative gearing. Obviously with more people bidding, the price will go higher.” ; Not everyone is in agreement with this view, however, with some analysts calling the "affordability crisis" a complete myth. ; According to Terry Ryder, director of Hotspotting.com.au, its owner-occupiers, who account for the vast majority of the housing market, who are pushing prices up the most: ; “They comprise the bulk of the market and they have the capacity to pay top price. They never get talked about and generally they’re the impetus for rising prices.” ; If negative gearing is dropped, and it's a very big if, there is also a danger that decreasing supply will lead to rising rents, causing additional hurt for people in the market for their first home.