Budget Forum 2016: What’s Not in the Budget, Tax Reform to Broaden the Income Tax Base.
4 May 2016, by David Ingles and Miranda Stewart

The Budget promises some tax cuts and puts some limits on tax breaks for superannuation. But the Budget does not deliver tax reform. It fails to strengthen the tax base of our most important tax – the personal income tax. In particular, it fails to address the gap in our income tax base from negative gearing and the capital gains tax (CGT) 50% discount.

The Treasurer said in his Budget Speech, “We will not remove or limit negative gearing – that would increase the tax burden on Australians just trying to invest and provide a future for their families.”

In contrast, the ALP proposes to limit negative gearing tax concessions for rental property investors to new investors in new housing. The ALP also will halve the 50% CGT discount to 25%.

What is negative gearing and why is it a problem?

Under Australia’s income tax, all expenses on a rental property investment, including interest on the loan to buy the property, can be deducted against wages and other income, not just against rents and investment income.

About 2 million taxpayers invested in rental properties in 2013-14, most having one or two properties. 1.25 million were negatively geared with nearly $11 billion in losses. Less than 10% of investors are investing in new construction. Taxpayers claimed $44.1 billion in rental property deductions of which the single biggest deduction was $23 billion of interest expense.

If most investors make losses, why do they do it? They are chasing low taxed capital gains. Indeed, Australian rental property investors have been increasing rental investments and making net losses since 2000, in a massive surge since the 1999 introduction of the CGT 50% discount. The Tax Expenditure Statement 2015 estimated that the CGT discount costs revenue of $6.15 billion, projected to rise to $8.57 billion in 2018-19.

Since we usually allow income tax deductions for all expenses, why should property investment be any different? The main reason is easy access to bank finance and the flexibility rental property investors have in gearing up their investment and deferring tax on the gain. It’s true that share investments can be negatively geared, but shares have to be paying dividends to be eligible and share interest expense is a fraction of the interest on rental properties – banks won’t lend much on this riskier asset.

Read the full article at Austaxpolicy Blog.