RBA recommends a review of negative gearing

The Reserve Bank has recommended that Australia's negative gearing rules be reviewed, telling a Senate committee inquiry into home ownership that it was not in the interests of financial stability to have tax law that encouraged over-leveraging into property.

The Senate Standing Committee on Economics is inquiring into current rates of home ownership, demand and supply drivers in the housing market, the changing mix of investors and owner-occupiers and the impact of tax policy.

The RBA submission said: "There is a case for reviewing negative gearing, but not in isolation."

The RBA said the ability to deduct legitimate expenses incurred in the course of earning income was an important principle of Australia's taxation system and interest payments were no exception to this.

And it said that, to the extent that negative gearing induces landlords to accept a lower rental yield than otherwise, it may be helpful for housing affordability for tenants.

"However, the interaction of negative gearing with other parts of the taxation system may have the effect of encouraging leveraged investment in property," it said.

It said the switch in 1999 from calculating capital gains tax at the full marginal rate of the real gain to calculating it as half the taxpayer's marginal rate on the nominal gain resulted in capital gain-producing assets being more attractive than income-producing assets for some combinations of tax rates, gross returns and inflation.

"This effect is amplified if the asset can be purchased with leverage," the RBA said.

Data presented in the RBA submission showed that the home ownership rate in Australia has been steady at around 70 per cent since the 1960s.

The RBA said the ownership rate appeared neither unusually high nor unusually low when compared to other countries. Financial deregulation, population ageing and rising real household incomes have contributed to higher home ownership rates in many countries besides Australia over the past 40 or 50 years.

However, there have been changes in home ownership among different age groups in Australia. The home ownership rate for typical first-home buyer age groups has drifted down over several decades. This trend has been offset by the ageing of the population, keeping the overall ownership rate stable.

It is the decline in home ownership among younger households that has attracted attention.

The RBA said various factors account for this decline: the rise in the median age of marriage since the 1970s and later household formation; and the increase in the number of single adult households.

The sharp rise in house prices since the mid-1990s is another factor, although this has been offset to a large extent by low interest rates. Affordability, measured as the share of income required to service a loan, has remained fairly constant but the increase in the size of a mortgage deposit has become an obstacle for many.

The rate of household formation is another factor. After relatively stable growth from the 1990s through to the mid 2000s, Australia's population growth stepped up significantly owing to higher net immigration.

At the same time, average household size has declined, leading to an increase in demand for housing for a given level of population.

A trend that has attracted a lot of attention has been the increase in the proportion of housing stock owned by investors.

According to the 2011 Census, around 68 per cent of the occupied housing stock was owned by owner-occupiers, government-owned housing accounted for five per cent and the remaining 26 per cent was rented from investors.

In recent years investors' share of housing loan approvals has risen to around 40 per cent.

The RBA said the share of investment properties that were geared has risen steadily since the late 1990s to around 80 per cent. The share of investors declaring a net rental loss and taking advantage of negative gearing benefits has also increased.

"Australia's treatment of property investors is at the more generous end of the range of practice in other industrialised countries, but not overwhelmingly so," the RBA said.

"There is a clear policy argument for ensuring that there are no artificial barriers constraining households from becoming home owners at some point in their adult lives."