How wealthy older Australians are using capital gains tax rules to distort the housing market

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The Grattan Institute CEO John Daley appeared on “Lateline” last night to discuss housing affordability in Australia with host Tony Jones.

Daley didn’t want to be drawn on RBA governor Glenn Stevens’ comments that in some parts Sydney property prices were “crazy”.

He said “it seems to me pretty obvious that there’s a problem”.

“I wouldn’t presume to give the governor advice as to whether or not Australian prices are overvalued. But what we can say is that we’ve got this big gap between the middle and outer parts of our cities.”

But Daley was much more forthcoming when Jones asked him about the impact of negative gearing and “John Howard’s cuts to capital gains tax in the year 2000”.

Daley explained how the negative gearing tax shelter works:

The issue is this: that you can go – you buy a house to invest in it. You claim the cost of interest that you pay to the bank for the loan. As a result of that, you make an operating loss in each year. The interest is more than whatever you’re getting in in rent and you claim that interest as a deduction against your marginal rate of tax. Let’s say you’re a reasonably high income earner, you claim that deduction at 49 cents in the dollar. But when you come to sell the house and you make a capital gain on it, because the capital gains are now discounted by 50 per cent, you’re only going to pay tax at 24 cents in the dollar.

Daley highlighted that this mismatch between the rate at which deductions are claimed, 49%, and the rate that capital gains are paid, 24%, is a key driver of the surge into investment property purchases.

“That’s one of the things that’s made it so attractive and indeed we can see that rates of negative gearing really lifted quite materially from 2000 and onwards and we now have in the order of 1.3 million taxpayers who are negatively gearing properties and claiming a deduction on their tax,” Daley said.

Daley said there was an intergenerational element to what is happening in the housing market as well.

I think there’s other, bigger things going on as well. We’re seeing an older generation that has quite a lot of assets that’s benefited from a combination of quite generous tax and welfare treatment and has also been in the right place at the right time as interest rates came down and therefore asset prices rose and we have a quite wealthy older generation, indeed an older generation that’s much more wealthy today than people of that age, say, 20 years ago. And that’s the generation that’s got money now to invest in owner – sorry, in investor housing.

So while older Australians, Baby Boomers, get rich and richer, their children are being shut out of the market, Daley said.

“The younger generation, particularly those, say, 25-to-34, have actually less wealth than 25-to-34-year-olds eight years ago,” Daley said.

“And that shift in wealth towards an older generation is effectively also resulting in a shift away from young people owning houses to occupy them, towards an older generation owning houses to rent them back to that younger generation.”