The volumes comprising the annual federal budget papers always tell more than one story. There’s the headline version, the one the government wants to promote, and then there’s what the detail reveals about underlying conditions, the likely impact of decisions and sometimes the motivation for making them.
Tuesday’s budget is especially instructive on all that because it contains actual structural change and comes at a volatile time of high financial stress and extraordinary global uncertainty.
In seeking to justify their centrepiece decision to break an election promise and start to unwind investment tax concessions, especially around housing, Treasurer Jim Chalmers, Prime Minister Anthony Albanese and their colleagues have offered three main reasons.
First, they argue that the changes will start to address the housing crisis by ending negative gearing for new investors buying established homes, but allowing investors in new housing stock to still negatively gear. This is despite the budget papers revealing that in putting downward pressure on prices, the changes will actually reduce available housing stock by 35,000 over 10 years – and temporarily increase median rents by about $2 a week. The government will only achieve a projected net increase of 30,000 dwellings by injecting $2 billion into fast-tracking the new-suburb infrastructure needed to get houses ready for sale, a move it says will create 65,000.
They also say their decision is about intergenerational equity, meaning it will help make homes more affordable and give young people a better chance at buying their first without having to compete with so many deeper-pocketed investors. And they say it’s about “rebalancing” the tax system so it skews less in favour of people who earn passive income from investments rather than the majority who earn income through work. That is a direct response to the increasingly loud complaint being conveyed through focus-group research that the system is more generous to those with two houses than those with two jobs.
There’s a fourth reason for the changes that’s not being so overtly articulated but is buried in the budget papers. It goes to the broader impact these generous concessions have had on the economy since their introduction in 1999, and what might happen if they’re wound back or if they’re not.
The papers show that over the years, taxpayers’ combined ability to negatively gear losses from an investment property against other income, and have capital gains tax discounted by a flat 50 per cent, has heavily influenced the kinds of investments Australians make and how much they borrow to do it.
When it was introduced, the CGT discount, in particular, was supposed to encourage more people into the sharemarket. In recommending the change, the 1999 Review of Business Taxation said it was designed “to enliven and invigorate the Australian equities market, to stimulate greater participation by individuals, and to achieve a better allocation of the nation’s capital resources”.
It hasn’t turned out that way. Treasury’s analysis in the budget shows that, since 2001, the proportion of taxpayers who’ve chosen to invest in the sharemarket has actually fallen, while the group investing in property has “grown considerably”. The arbitrary flat 50 per cent CGT discount, which applies to assets held for more than 12 months, replaced a system in which only real gains were taxed, minus whatever was attributable to inflation. Treasury says compared to the old cost base indexation, the 50 per cent discount has ended up overcompensating some investors and undercompensating others.
Those who got the best deal from the flat-rate discount were in property because inflation only accounted for an average 38 per cent of capital appreciation on property assets held for 10 years, so it delivered them a windfall compared to the old tax method. In contrast, over the past 15 years, Treasury says inflation accounted for more than 50 per cent of share-investment gains, meaning the flat-rate discount has undercompensated those investors. They would have been better off if things had stayed as they were.
The upshot of all this is that, since the system changed, it’s been much more lucrative, in tax terms, to invest in property than in shares. Over 20 years, inflation has accounted for just 33 per cent of the growth in property values while they’ve attracted a tax discount of 50 per cent. For shares, the inflation impact was 43–50 per cent, so the tax benefit was less generous.
Within the property market, you’ve done better still if you invested in established freestanding houses than in units or apartments. This is because inflation only accounted for 31 per cent of the 20-year capital gain on houses but 42 per cent on apartments. On apartments held for less than 20 years, inflation accounted for well above 50 per cent of gains, meaning in tax terms they were a bad investment. For houses, it was below that for the whole time.
Add in the ability to negatively gear a property investment, and the tax system has created a huge incentive for people to buy, hold and then sell existing freestanding homes rather than medium-to-high-density housing, or shares. Because the inflationary impact has been even higher in regional areas, the tax disadvantage in buying apartments there has been even greater.
Treasury finds that a third of all capital gains on investments are made by those who were among the highest 1 per cent of income-earners during their working lives and more than half by those in the top 10 per cent. This adds some perspective to the “Mum and Dad investors” line spruiked by the Howard government when it was privatising government assets.
But here’s the real kicker. The huge incentive to invest in property that the combined CGT discount and negative gearing created has prompted many people to over-leverage – borrow more than they could really afford – and then pay too much for an asset because the system rewarded investors whose outlay was greater than the income generated.
“This leads to higher house prices – as investors bid up the price on a scarce resource to receive the concession,” Treasury says in statement four of budget paper number one. “It also distorts investments away from higher-income-generating assets with lower capital returns, such as higher-density housing, and investments in shares that are less easily funded with leverage.”
Combined with changes to business taxation and incentives to attract venture capital, the budget papers say the tax changes are expected to “support investment, innovation, risk-taking and resilience”.
This official confirmation that many people have overreached on borrowings during the low-interest-rate period that preceded the current cost-of-living crisis – which logically means they’re at risk of defaulting on their loans as interest rates rise – may have something to do with why major banks’ share prices have plunged in the days since the budget.
It also amounts to reason number four for breaking the promise and phasing out the concessions: to stop people overextending and encourage them to base investment decisions on more than just getting a hefty tax break.
“The reforms to negative gearing and capital gains tax are expected to improve the efficiency of investment decisions, as they are more likely to be made for economic reasons rather than tax outcomes,” the papers say.
In other words, the changes are partly designed to save people from themselves and help save the economy too. When they talk about “resilience”, that’s what they mean.
