"Negative gearing" was a big topic in the Australian election. The Labor party claimed that it was unfair, and they proposed getting rid of it. They said it propped up property prices, it encouraged speculation in property, and it delivered tax benefits to the rich.
Top property businesses such as the Real Estate Institute and the Property Council of Australia fought against it, claiming that anything that decreased property prices would be bad.
Just like Australia, New Zealand has rampant property prices, and just like Australia, our tax system allows negative gearing. It's a conversation we ought to be having too.
Negative gearing is the practice of investing in property, expecting that the income earned by the property won't be enough to cover the costs of owning and managing it.
In other words, the "investor" expects to make a loss. In concrete terms, it's like buying a rental property and renting it out for $30,000 a year, but expecting to pay $35,000 a year for interest and rates and other expenses.
That might not seem so bad if an investor is prepared to take the loss. Where the practice becomes complicated is when the loss can be written off against the investor's other income.
For example, a person might earn $100,000 a year in their job, and have a rental property making a loss of $5,000.
When it comes to the end of the tax year, that person is taxed on $95,000 income overall.
The loss on the rental property reduces their income by $5,000, and thus reduces their overall tax bill by $1,650. In effect, other taxpayers end up subsidising their poor investment.
Writing off losses in one area against income in another area happens all the time in the tax system and, most of the time, it's not a problem. People who make bad business decisions eventually go out of business or, alternatively, after a while they start making profits which are subject to taxation, just like any other income.
The problem with negative gearing is that at present, investors expect to make their money in the long term out of untaxed capital gains. They wear the short-term, tax-subsidised losses on their rental properties, in the expectation that eventually they will sell the property and the money they make will far outweigh any losses they've accumulated along the way.
Tax-deductible negative gearing is likely to be one of the many factors pushing prices ever higher in Auckland.
We know that a fair amount of it is going on: in response to an OIA request, Inland Revenue confirmed that in the 2014 tax year, rental property owners claimed about $780m in tax losses. That could amount to a tax subsidy of up to $250m.
One simple way to remove this subsidy, and hopefully provide a slight cooling influence on the property market, is to not allow losses on rental property income to be claimed against other income. Rental property investors could still carry the losses forward, and offset them against any profits that they ever make from residential rentals, but they couldn't write the losses off against other income, like salaries or business income.
Of course, the Property Investors' Federation wouldn't like this proposal, and no doubt they would flex their lobbying power to ensure that the government doesn't do it.
Removing tax subsidies for negative gearing is one of the many levers the government could use to calm property prices down.
SHARE THIS QUOTE:
Tax purists won't like the proposal either.
These are people who argue that income is income, and it doesn't matter what the source of that income is, all income should be taxed alike. That way, we maintain consistency and fairness in the tax system.
As a tax thinker myself, I'm sympathetic to this argument.
Having consistent rules in the tax system makes for a fairer system. Once we start putting special rules in place for certain types of businesses and activities, we open ourselves up to a morass of sticky issues and potential loopholes.
But we already have one enormous inconsistency in the tax system which opens the door for negative gearing, and that's the lack of a proper capital gains tax.
While that inconsistency sits in the system, it's hard to be precious about others.
When it comes to the alarming house prices in Auckland and increasingly in other cities too, it's clear that our purist approach to tax is not serving us well.
Removing tax subsidies for negative gearing is one of the many levers the government could use to calm property prices down. Perhaps they should start investigating it. Urgently.