High personal income tax rates are driving middle-to-high-income property investors in Australia to utilize negative gearing strategies, according to new research from the Australian National University’s Tax and Transfer Policy Institute. This finding challenges the narrative promoted by some political factions, including the Greens, who argue that tax breaks benefit greedy landlords while pushing younger buyers out of the market.
The study, led by economist Christian Gillitzer, a former analyst at the Reserve Bank of Australia and current lecturer at the University of Sydney, reveals that high income tax rates create incentives for taxpayers to become leveraged landlords. In particular, the research indicates that the recent redistribution of tax breaks by Treasurer Jim Chalmers has made negative gearing even more attractive for those in higher income brackets.
Gillitzer’s working paper examines taxpayer behavior in response to tax incentives related to rental properties, especially where capital gains are taxed at reduced rates and rental losses can be fully deducted against labor income. His analysis, which included data from significant tax rate cuts made between 2006 and 2011 by both the outgoing Howard Coalition government and the incoming Rudd Labor government, shows a marked decrease in the likelihood of holding an investment property with a negative net rental position when marginal income tax rates drop.
The research highlights a specific case where the marginal tax rate for certain high-income earners decreased from 45% to 37% due to an increase in the income threshold. This adjustment resulted in a significant decline in ownership of loss-making rental properties among affected taxpayers. Gillitzer notes, “Ownership of debt-financed rental properties in Australia is concentrated among top earners and significantly decreases when marginal income tax rates fall.”
To illustrate the implications of high income taxes, consider an employee earning $300,000 per year. This individual faces a tax burden exceeding $110,000 from various income tax-related payments. Given these financial pressures, it is not surprising that such taxpayers seek ways to reduce their tax liabilities, with negatively gearing an investment property being one of the few available options.
Australia’s taxation system uniquely allows net rental losses to be fully deductible against labor income. Deductions cover a range of expenses, including mortgage interest and various property-related fees. Higher marginal tax rates amplify the incentive to invest in property, as investors can significantly decrease their taxable income while also anticipating future capital gains, which are taxed at a lower rate.
The political landscape is evolving as discussions about negative gearing and the capital gains tax (CGT) discount gain traction. In 2024, Chalmers tasked Treasury with reviewing these tax incentives, recognizing their significant implications for high-income earners. A paper released by Treasury suggested that negative gearing and CGT discounts contribute only a modest increase in home prices, estimated between 0.5% and 4.5%, in the context of broader market trends.
Despite these modest effects on home prices, curtailing tax breaks for property investors raises concerns about housing supply. Prime Minister Anthony Albanese has indicated that reducing these tax incentives might not lead to increased housing availability, as evidenced by Treasury’s findings. Any reduction in after-tax returns for investors could discourage developers from supplying new homes, potentially leading to higher rents.
Political motivations are likely to drive calls for reform in property tax incentives, framed as measures to enhance housing affordability. Yet, discussions about the impact of high personal income tax rates are often overlooked. Former Treasury official Geoff Francis cautions against misinterpreting Gillitzer’s findings as a justification for stricter limitations on negative gearing. Instead, he suggests that they could advocate for flatter income tax rates.
Former Prime Minister Paul Keating has consistently argued that tax rates above 39% are excessively punitive. Chalmers’ adjustments in early 2024, which included reintroducing a 37% rate for earners between $135,000 and $190,000, reflect ongoing debates about income tax equity. Critics point out that if the top income threshold had kept pace with inflation over the past 15 years, it would now be around $270,000.
In conclusion, the interplay between income tax rates and property investment strategies presents a complex challenge for policymakers. While reforming property tax incentives might seem appealing, a comprehensive approach to tax reform that addresses both income taxes and property regulations could yield a more balanced outcome. By considering a flat tax rate for non-labor income, governments may enhance fiscal capacity while simplifying the tax landscape, thus promoting a fairer system for all taxpayers.
