This article is from the Australian Property Journal archive
THE Business Council of Australia has backed changes to negative gearing, however it recommends changes to be phased in to avoid fire sales and the BCA warned that limiting negative gearing to new dwellings only would distort the housing market.
The BCA’s discussion paper, Realising Our Full Potential: Tax Directions for a Transitioning Economy, said any changes to negative gearing would need to be phased in or grandfathered to avoid fire sales of properties and negative impacts on existing borrowers. The impact on rental markets would need to be assessed.
Speaking at the launch event in Sydney yesterday, BCA president Catherine Livingstone said real growth needs real tax reform.
“If we follow the framework for good policy, and we are agreed that a tax system which reinforces and complements our national capabilities is essential to delivering on our national vision … the next step is identifying the problems with the current tax system.
“The problems we have now include major issues with the structure, we are overly reliant on a volatile, narrow base of income taxes, both personal and company. 12 companies pay 33% of all company tax, and 3% of individual taxpayers pay almost 30% of personal income tax,”
Livingstone said Australia’s rate of company tax is one of the most uncompetitive in the world, adding to the already failing competitiveness.
“The complexity and inefficiency of the system has 10 taxes raising 90% of revenue, while the remaining 115 taxes impose significant compliance costs for very little revenue yield..
“Taxation can be either an accelerant or an impediment to economic growth – in our case it is increasingly an impediment. We see this in the decisions made, at the margin, by business and by individuals,” she added.
The BCA discussion paper identified eight directions of tax reform, including changes to negative gearing and capital gains tax, and land taxes and stamp duties.
“There is much debate about the fairness of interest deductibility for rental properties (negative gearing).
“Despite its general availability, when used for buying property, negative gearing is regarded as favouring high-income earners. Negative gearing is used across all income groups. One-third of rent received, one-third of interest and one-third of other deductions are claimed by those with taxable income between $37,000 and $80,000.
“Despite its widespread use, it is estimated that most of the benefits of negative gearing accrue to higher-income earners. In part this reflects progressivity of the income tax system as the value of any deduction increases with the tax rate,” the paper said.
The BCA said negative gearing must be considered together with tax treatment of capital gains, as ultimately there is only value in negative gearing if a net gain is obtained.
“It is considered by Treasury and others that to the extent there is a problem, it lies in the tax treatment of capital gains.
“The budget cost of negative gearing to purchase rental properties is estimated to be around $3 to $5 billion a year (it has declined due to low interest rates). But removing negative gearing on properties is unlikely to raise this amount as investors would likely switch to holding other assets,” the paper said.
The BCA said changes to negative gearing should align with treatment of other savings vehicles.
“Changes to negative gearing without more neutral tax treatment of savings across different asset classes are likely to shift investors into other assets. This would reduce any potential revenue gain,”
The BCA identified numerous options for changing negative gearing, including:
– limiting the number of negatively geared properties
– capping the total amount of deductions for negatively geared property
– quarantining interest deductions against rental income
– limiting negative gearing to new dwellings only.
The BCA looked at the consequences of each option:
– Limiting the number of negatively geared properties would have a limited impact and would not raise much, if any, revenue – people could simply purchase fewer, more expensive properties.
– A cap on deductions would likely affect mainly high-income earners (depending on the level of the cap). Those affected would shift to other assets to some degree, such as shares, which would reduce scope for revenue gains. A universal deduction limit (covering work expenses, interest, donations etc.) would essentially impose a minimum effective rate of tax on higher-income earners.
– Quarantining interest deductions against rental income would limit the immediate benefits of negative gearing but losses would be carried forward to reduce taxable capital gains when assets are sold. This changes the timing of claiming losses, but not the capacity to claim them.
– Limiting negative gearing to new dwellings would distort the housing market.
Currently, most negatively geared properties are existing dwellings, presumably reflecting demands in the rental market and that new housing will always be a relatively small share of the total housing stock.
“If negative gearing is confined to new dwellings, investor demand will shift to new dwellings, pushing up prices of new dwellings in the short term (given a less than perfectly elastic supply response) and crowding out owner-occupiers.
“Overall there would be a likely decline in demand for housing. The extent of the decline in demand would be limited if losses can be carried forward in the cost base for capital gains, but this would also limit the scope for net revenue gains. Only expanded supply of housing can increase the housing stock and keep a lid on prices,” the paper said.
The BCA suggested a dual-income tax approach.
“Under a dual-income tax approach, interest and other property expenses could only be offset against rental income, which would still be taxed at a concessional rate. Losses would be carried forward until properties were sold and (concessional) capital gains tax paid. This would offer immediate revenue savings (depending on the discount on rental income), offset by lower capital gains tax receipts in future,”
The BCA also said capital gains should be concessionally taxed. In 2015-16 the CGT discount on assets owned by investors for at least 12 months is estimated to be around $6 billion.
“Two main issues have been raised with the current system – the size of the discount and that it applies to nominal rather than real gains.
“There is broad consensus that savings income should be taxed concessionally. However, there is no theoretical guidance on how large the concession should be. The current discount of 50% may be generous, particularly in a low-inflation environment.
Applying the discount to nominal capital gains can distort investor behaviour, particularly at a time of rapid capital gains, such as in a housing or equity boom. On the other hand, if capital gains lag inflation, the current regime works in the opposite direction to penalise investors,” the paper said.
The BCA proposed a number of changes, including reducing the CGT discount to 25%.
For example, if an asset was purchased for $100,000; sold for $110,000 a year later (nominal gain of $10,000); inflation is 3%; and the taxpayer is in the highest tax bracket (49% tax rate including levies).
Under the current treatment (involving a discount of 50%) the effective marginal tax rates (EMTR) on the real gain would be 35%. The EMTR would rise to 53% under a 25% CGT discount, resulting in more tax being paid than if the real gain were taxed at the taxpayer’s full marginal rate.
“It is estimated that around three-quarters of the benefits from the CGT discount goes to households in the top income decile. However, capital gains tend to be large one-off benefits, which can significantly raise taxable incomes, even pushing taxpayers into higher tax brackets than would otherwise be the case. This can skew the analysis,”
The BCA said a way forward would be to explore reducing the capital gains tax discount to 40%, but only as an initial step towards more consistent concessional taxation of other forms of savings income.
“Existing asset holdings would either need to be grandfathered or the reduction in the discount phased in. Grandfathering would push out savings for many years,”
The discussion also said there is scope to use the land tax base better.
“The marginal excess burden of a broad-based land tax is estimated to be negative – that is, raising land taxes would deliver an economic benefit. The benefit would be even larger if the revenue is used to remove more economically harmful taxes like stamp duties,”
According to the BCA, currently around 60% of the value of land is exempt from land tax, applying largely to a range commercial and investor-owned residential land, whilst exemptions apply to owner-occupied housing and land used in primary production.
“Significantly, these exemptions exclude from the tax base the land with the fastest recent growth in value.
“There are also large variances in the land tax rates and base across states. For a property valued at $600,000 the effective land tax rate varies from 0 to 1.39%, with a range of rates and thresholds,”
The paper proposes that as a rule of thumb, an effective tax rate of around 0.2% could be applied to all land (no exemptions) to raise the same amount of tax revenue as today. In 2013-14, states raised $6.4 billion in land tax on land valued at about $1.7 trillion, but total land values were $4.2 trillion.
“The land tax rules should be harmonised across states and the base expanded. Uniform rates would be ideal, but it would be possible for states to continue to set the land tax rates so they can adjust to their particular circumstances.
“Ideally, a reformed land tax would only apply to the unimproved value of the land, so there is not a disincentive to improve the land. Council rates could be used as the base for a low-rate broad property levy,” the paper recommended.
The BCA said a broad based land tax would reduce the state government’s reliance on stamp duties.
“Stamp duties are highly inefficient and volatile, making them harmful to economic growth and budget stability. Treasury estimates that each dollar of revenue raised through stamp duties on property costs the economy around 72 cents for an extra dollar raised.
“Stamp duties increase the cost of buying a house and discourage people and businesses from moving. This causes an inefficient use of the building stock. Stamp duties can discourage new housing development as the tax is paid twice: once by the developer when the land is acquired and again when the final owner buys the new house.
“While stamp duties increase with property values, they do not always treat people in similar circumstances in a similar manner. They place a higher tax burden on people who move more frequently and buy more insurance, which may not relate directly to their wealth or income,” the paper stated.
The BCA said stamp duty reductions and land tax increases could be phased in very gradually to avoid sudden shocks to the property market, similar to the approach taken by the ACT Government.
“Increasing land tax at the same time as reducing stamp duty has the additional benefit of some offsetting impacts on asset prices,” the paper said.
Australian Property Journal
