In a submission to the Senate inquiry into home ownership, the Reserve Bank suggests that it might be time to review the negative gearing arrangements for investment property.

To be fair, the RBA’s submission called for this review within the context of the entire taxation arrangements of investment property, of which negative gearing is simply one component.

Nevertheless, the significance of the RBA entering this debate is not to be underestimated.

The negative gearing rules in Australia allow investors to offset losses on their investment property against other income.

Opponents of negative gearing laws claim that this income tax reduction is essentially a subsidy that is not available to owner-occupiers. They also claim that this subsidy distorts the housing market, making housing unaffordable for ordinary Australians.

Some even suggest that it is responsible for the house price surges in Sydney and Melbourne.

However, a lot of these claims simply don’t stack up.

Myth 1: Negative gearing is responsible for the recent house price surges in Sydney and Melbourne.

Negative gearing rules have been in place for more than a quarter of a century and the number of investors taking advantage of them has been stable for well over a decade. The recent price rises are more closely related to supply restrictions and falling interest rates.

Myth 2: Negative gearing makes property unduly attractive for investors.

All investments, including property, can be negatively geared. Property competes, as an investment, on a level playing field. Abolishing the negative gearing rules for property would cause a market distortion, not cure it.

Myth 3: Negative gearing pushes aggregate prices out of the reach of average Australians.

There is simply no evidence that prices are skewed out of the range of the average Australian. The RBA made this clear to the Senate inquiry – the current cost of servicing new loans on housing in Australia is significantly lower than the average over the past decade.

Myth 4: Negative gearing benefits the wealthy at the expense of the poor.

Taxation statistics from the ATO show that of those declaring a net rental interest in recent years; approximately three-quarters earn less than $80,000 per annum.

Myth 5: Negative gearing rules make it more difficult for first home-buyers to enter the housing market.

This is one of the most contentious myths in the popular mindset. The reality is that by encouraging investment in housing, the supply of rentals increases which keeps rents low. For example, in inner-Sydney gross rental yields can be as low as 2.5 per cent in some areas. This benefits the renter, not the investor, and allows renters a better opportunity to save for a deposit for their own home. Abolishing negative gearing would, in the long-term, drive rents up and make it much harder for renters to get on the property ladder.

The reality . . .

Some commentators have suggested that rents did not increase during the 1985 negative gearing hiatus. However, housing markets are sluggish to respond to demand shocks. Building new property to address market undersupply or waiting for population growth to absorb oversupply takes many years. Also most leases are fixed for a significant length of time. Observations made in a single year do not disprove fundamental economic principles.

Even if the opponents of negative gearing are correct, and abolition did reduce house prices, how much wealth would be destroyed? A 10 per cent reduction in average house value equates to a $570 billion wealth destruction. This is people’s life savings and retirement plans, and it would hurt those currently with mortgages most heavily. Destroying wealth in one sector of the community to increase wealth in another is simply a wealth transfer form one group to another.

Similarly, making changes to tax rules that hurt the entire country simply to help a select few in Sydney and Melbourne is a wealth transfer from the regional areas to the city.

The reality is that abolishing negative gearing on property would create a market distortion, make it more difficult for future first-home buyers to save a deposit, increase rents and create significant wealth destruction and transfers.

If the government is serious about improving housing affordability, then it should explore options to increase supply and reduce the cost of inputs. Some suggestions include removing stamp duties, simplify and relax the complex planning system, reduce social housing, tighten trade-union legislation and increase urban infrastructure coverage.

Jamie Alcock is an Associate Professor of Finance at the University of Sydney Business School and specialist in the housing market.

Posted by Jamie Alcock – The Age on 19th July, 2015