Axing negative gearing won’t cause a rental crisis. Here’s the maths | Saul Eslake

One of the great urban myths of Australian political history is that "rents went through the roof" after then treasurer Paul Keating abolished negative gearing for property investors in July 1985 and as a result was "forced" to reintroduce it in September 1987.

In fact, this is an illustration of the saying that if a lie is big enough and you tell it often enough, it becomes accepted as the truth.

The truth of this episode is that rents did rise at double-digit rates in Sydney and Perth during this period – but that was because vacancy rates had fallen to barely above 1% in Sydney, and to about 2% in Perth, by the first quarter of 1986 (notwithstanding the incentives that the availability of negative gearing since at least the 1930s had ostensibly provided for investment in rental housing).

In other cities, where vacancy rates were higher, rent inflation actually fell during the ensuing two years in which negative gearing was unavailable – something that shouldn't have occurred if the abolition of negative gearing were to have had the effects claimed for it.

Nonetheless, advocates for the retention of negative gearing have continued to point to this episode as "proof" of what would happen to rents if the same thing were tried again.

But with the nation in the midst of a housing crisis, the idea of getting rid of negative gearing is being discussed .

The appeal of negative gearing to property investors was turbocharged by the changes to the capital gains tax regime made by then treasurer Peter Costello in 1999. Those changes replaced the system introduced by Keating in 1985 – which subjected capital gains to income tax at taxpayers' full marginal rates, less an allowance for CPI inflation over the period for which the asset had been held – to one which taxed capital gains at half the taxpayer's marginal rate, without any allowance for inflation (which by that time was much lower than had been in the mid-1980s).

This converted negative gearing from a vehicle which allowed taxpayers to defer taxation to one which allowed them to both defer and reduce taxation. It did this by, in effect, converting wage and salary income taxable in the year in which it was earned to capital gains, which were taxable at a (later) time of the taxpayer's own choosing.

Not surprisingly, the number of taxpayers who availed themselves of this opportunity mushroomed from fewer than 700,000 in the late 1990s to almost 1.4 million by the late 2010s.

The numbers declined after that because ultra-low interest rates made it more difficult to be a negatively-geared investor. But the Parliamentary Budget Office has estimated that the cost to the federal Budget, in terms of revenue foregone, of negative gearing will rise from a low of $2.1bn in 2021-22 to $10.2bn by 2029-30 and to $14.5bn by 2034-35.

Defenders of negative gearing also like to claim that most of those using it are people with taxable incomes of less than the top tax threshold – or, as they often put it, "Mums and Dads just trying to get ahead", as if that in itself is reason enough to leave it in place.

In fact, Australian Taxation Office statistics show someone in the top tax bracket is more than three times as likely to be a negatively-geared property investor than someone who is not.

ABS housing finance statistics show over three-quarters of lending to property investors is for the purchase of established, rather than new, housing. That is, the overwhelming majority of residential housing investment does not add to the supply of housing – rather, it simply drives up the price of the housing we already have.

Every time an investor outbids a would-be owner-occupier on an established property, they are adding to the supply of rental housing – but they are also adding to the demand for rental housing by exactly the same amount.

So, yes, if negative gearing were to be abolished for investors in established housing and that were to result, as we are routinely warned, in a reduction in investment in established housing, that would indeed reduce the supply of rental housing.

But since that housing would instead be bought by aspiring owner-occupiers, it would reduce the demand for rental housing by exactly the same amount. And hence there would be no impact on rents. None at all.

People who insist otherwise are only telling half the story. Calling them out will lead to a more honest discussion.

Saul Eslake is a vice-chancellor's fellow at the University of Tasmania and an independent consulting economist. He has served as a member of the Parliamentary Budget Office's expert advisory panel and on the Australian Taxation Office's "Tax Gap" expert panel. This piece was originally published under a creative commons licence at 360info .