Negative gearing allows households that incur losses on rental income to deduct these losses from other sources of income. The Greens are currently advocating for the abolishment of negative gearing, as did the Australian Labor Party during their unsuccessful 2019 election campaign.
The standard arguments surrounding negative gearing are two-fold. First, it provides a potential subsidy to housing investors, thereby increasing the supply of housing in the rental market. This directly benefits housing investors by reducing their tax burden and indirectly benefits renters by lowering housing rental prices.
The second issue is that negative gearing is costly. By allowing losses on rental investment to be deducted from other sources of income, the government generates less revenue than it would otherwise. How this additional revenue, if raised, is used will determine the cost of negative gearing.
In our research, we study the role of negative gearing in the Australian economy. We examine removing negative gearing in an economic model that incorporates variations in households’ age, income, and wealth. This framework enables us to capture the distributional effects of any policy change and analyse welfare changes.
Within our economic model, we consider two alternatives. First, the additional tax revenue is redistributed to all households in a lump-sum fashion. An example of lump-sum transfers would be stimulus packages where the government provides the same amount of subsidy to all households.
In our second experiment, we implement a policy that provides a targeted transfer only to renters. This could be rental assistance, or transfers directed to low income or wealth families.
Alternative 1: Redistribution to all households
When the proceeds from abolishing negative gearing are used to redistribute to all households in a lump-sum fashion, we find that the long-run welfare gains from abolishing negative gearing and redistributing the tax savings to all households are small, equivalent to a boost in lifetime consumption of 0.13 per cent.
Looking at the short-run welfare gains, we find that they are slightly larger but still small. This suggests to us that the efficiency loss from negative gearing is relatively small.
To understand these results, we note several market failures in our model that are relevant to understanding the housing market and the role of tax policy.
One novel aspect of our research is highlighting a significant amount of risk in housing investment, taking the form of uncertainty in capital gains, rental income, and rental expenses.
Without insurance markets, this risk may reduce the willingness of housing investors to supply dwellings in the rental market below socially optimal levels. Negative gearing subsidises losses and provides implicit insurance against risk in housing investment. Therefore, negative gearing could provide a social benefit by encouraging investment that is partly discouraged by the lack of appropriate insurance markets for housing investors.
When negative gearing is repealed, and the additional tax revenue is redistributed in a lump-sum fashion, the implied welfare gains are, on average, small.
Alternative 2: Rental assistance
On the other hand, we find much larger welfare gains when revenue raised from the repeal of negative gearing is redistributed in the form of rental assistance.
In this scenario, the removal of negative gearing again leads to tax revenue, and this additional tax revenue is distributed to renters. The long-run welfare gain is equivalent to a boost in lifetime consumption of 1.45 per cent. The much larger welfare gains stem, at least in part, from the fact that households face risk in the labour market.
Renters tend to have lower incomes, and in our model, this implies that they are more vulnerable to less favourable income shocks. The provision of rental assistance thereby acts as partial insurance against bad luck in the labour market.
Furthermore, our model economy features credit constraints. The provision of rental assistance allows households to better respond to income shocks, which also raises welfare.
Effects on purchase and rental prices
Beyond welfare, we also study how changes in negative gearing affect housing rents, the purchase price of housing, and the breakdown between rental and owner-occupied housing.
Typically, removing negative gearing removes a subsidy to housing investment and reduces the size of the rental market and investor demand in the purchase market. These effects tend to lower the purchase price of housing and raise rental prices. This coincides with a shift in tenants away from rental housing and towards owner-occupied housing.
Overall, the decline in the purchase price from removing negative gearing are small. The increases in the rental price of housing are larger.
What are our conclusions?
Housing investment is risky, and insurance markets are imperfect. As a result, negative gearing can play a role in supporting investment in housing that may otherwise be discouraged. Despite this, in our model economy, policies to support renters, and in particular, low-income renters, are likely to be welfare improving.
An important caveat is that our model does not account for the incentive effects of taxation on labour supply decisions. That is, the evolution of labour income is independent of the level of redistribution. Arguably, policies to support low-income households may encourage households to exert less effort in the labour market.
Journal article
Cho, Y., Li, S.M. and Uren, L. (2024), INVESTMENT HOUSING TAX CONCESSIONS AND WELFARE: A QUANTITATIVE STUDY FOR AUSTRALIA. International Economic Review. https://doi.org/10.1111/iere.12673
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